Janet Yellen, who has been nominated to Fed vice chairwoman and is currently president of the San Francisco Fed, argued that raising the Fed's presumed inflation objective of 4 per cent, as proposed by some prominent economists, could be dangerous.

'A higher long-run inflation objective would give the Fed more maneuvering room in the future,' she said. 'But, any such benefit would be counterbalanced by other factors, including the potential erosion of the Fed's hard-earned inflation credibility and the economic costs of higher inflation and interest rates.'

Before anyone jumps to the conclusion that Frankfurt is a stop on my road to Damascus, let this Saul state that for me the case remains open.  Inflation has come down worldwide, in countries without, as well as with, inflation targets.  Moreover, I share David's puzzlement about why an explicit inflation goal should make a substantial difference in performance given the paucity of evidence showing that choosing a target directly affects the level of the public's inflation expectations.  That said, I am relatively more persuaded that inflation targeting helps reduce the variance of inflation expectations.

    "We already enjoy considerable credibility. And I just mentioned that we've had huge fluctuations in oil prices showing barely a ripple in long-term inflation expectations. So the benefits are probably, I'm sure, are much smaller in the U.S. than they would be in many other countries.
     ``And then we do have to worry about the costs, about whether anchoring expectations a little bit better -- that expectations are already very well-anchored, but having that marginal influence, what are the tradeoffs, both in terms of the flexibility and in terms of making people understand what we're doing, how it's consistent with our dual mandate, etc.
     ``So this is the nature of the discussion that's going on.  But I think it's less clear-cut in the U.S.''

From the Q& A session, as reported by Bloomberg News

It is a very early stage of the discussion and at this stage I wouldn't read into that [inflation targeting] is inevitable.  I am undecided on this.  I am still studying it...  It should take a while to work through because it is not something you do willy-nilly, it's something you do with great deliberation.

From an interview with Reuters News

So we have to be careful not to focus too narrowly on one particular measure. Instead we need to look at many. And indeed here in the United States we look at a range of different measures of core inflation, for example, that take energy and food prices out of the overall index. We look at these over different time horizons. We look at a variety of other measures that use different statistical techniques to strip out the more volatile parts of the index. These all have limitations, and their relative merits may change over time. Central banks approach this challenge of capturing underlying inflation differently, but ultimately we are all judged by what happens to overall inflation over time.

As yet unresolved is whether the mere announcement that a central bank intends to engage in inflation targeting increases the credibility of the central bank's inclination to maintain price stability and, hence, assists in the anchoring of inflation expectations. The Bank of England's recent experiences may be encouraging in this regard. But, presumably, we will not know for sure the significance of formal inflation targeting as a tool until the world economy is subjected to shocks of sufficient magnitude to assess the differential performance of those who do not employ formally announced inflation targets. To date, inflation has fallen for formal targeters, but it has fallen for others as well.

I do not believe that inflation targeting, in any meaningful sense of that term, describes what the Federal Reserve has been doing over the last twenty years, or even in recent years, when Marvin [Goodfriend] claims that policy has evolved into "implicit" inflation targeting. Instead, the success of U.S. monetary policy has in large part derived from its ability to adapt to changing conditions--a flexibility that likely has benefited from the absence of an inflation target. Nonetheless, the U.S. economy has enjoyed most of the benefits ascribed to inflation targeting in terms of anchoring inflation expectations as well as inflation itself. It is the focus on long-term price stability that has fostered these benefits, and I believe that this focus will not be at risk with a change in personnel at the Federal Reserve. Considering these points, I am skeptical that for the United States the potential benefits of changing to a regime of inflation targeting would outweigh its possible costs.

In addition, at few key junctures in the past five years, the Federal Reserve exercised a more flexible monetary policy than inflation targeting probably would have suggested or allowed. The first occurred in reaction to the "seizing up" of financial markets that followed the Russian debt default in the late summer of 1998. Although forecasts were marked down at this time, the easing was faster and larger than would have been suggested by Taylor-type rules based on our past pattern of behavior and incorporating an implicit inflation target. In effect, to protect against the potential for a really bad outcome for markets and economic activity, the policymakers raised the most likely outcome for inflation--or at least skewed the risks toward the possibility that inflation would pick up. Similarly, in 2001, easing was unusually aggressive, even before September 11, as the extent of the demand shock gradually revealed itself. To be sure, when one looks back, the outcomes in both instances in terms of stable inflation were not any different than inflation targeting would have sought. At issue, however, is whether the FOMC would have responded so aggressively to these shocks if it had been constrained by an inflation target. It is a matter of how the central bank is likely to weigh the risks and rewards of various courses of action--where it takes its chances. My sense is that, given the stress on hitting inflation objectives, the pressures of an inflation target would have constrained flexibility that in the end turned out to be useful.

This strategy of conducting monetary policy has been widely adopted around the world, and it has seemed to be successful in lowering inflation and perceptions of future inflation. It has a potential drawback in ignoring explicit consideration of output gaps and unemployment, but perhaps because it has been applied flexibly and in a forward-looking manner, in fact it has not seemed to generate more unemployment than other monetary regimes would have. It also may not work as well in times of negative supply shocks, though this point remains to be tested.

Other instances in which inflation targeting might not work so well are negative supply shocks, such as most economies experienced in the mid-1970s when oil prices exploded. In these times, inflation rises just as output falls. The most flexible and competent central bank in the world would be faced with a difficult dilemma in such circumstances--forestall the recession by making inflation worse or limit the inflation by making the recession worse. But at least such a central bank would have a choice. In general, an inflation-targeting central bank would not have much of a choice. It would be forced to try to limit the inflation by contractionary policies, hence making the recession worse. Even a flexible, forward-looking inflation-targeting central bank would not have much freedom in such a situation, because in the end the central bank would be evaluated much more on its success in meeting inflation targets than in meeting output growth targets.