Book reviews

Edwin M. Truman, Inflation Targeting in the World Economy, Institute forInternational Economics, 2003

It is not every day that one gets to observe the genesis of a new monetary policy

framework. The introduction of inflation targeting (IT) in the early 1990s, and its

subsequent adoption by over 20 central banks, has created just such an opportunity,

however. And few economists were better positioned to observe IT’s development than

this book’s author, who served during this period as head of the Federal Reserve Board’s

Division of International Finance, and later as assistant secretary of the Treasury for

international affairs. In light of the author’s extensive policy experience, it should come as

no surprise that the book contains a wealth of fine-grained institutional detail—a treat for

connoisseurs of monetary policy, not just IT mavens. Indeed, with its discussion of a

variety of related topics, including exchange rates, financial stability and political

economy issues, Truman’s wide-ranging treatise should be of interest to any policy-

oriented economist looking for an accessible introduction to the IT literature.

The book makes a number of important contributions to the discourse on inflation

targeting. First, it provides an up-to-date overview of the practice of IT around the world,

and a comprehensive survey of the rapidly expanding literature on the topic. Second, it

presents quantitative estimates of IT’s effects on macroeconomic outcomes in the countries

where it has been adopted. And third, it presents an even-handed, dispassionate assessment

of the advantages and disadvantages of IT relative to other monetary policy frameworks,

for both emerging-market and industrialized economies, culminating in a broad-based

endorsement of the IT framework for a wide range of countries.

The book’s perspective is uniformly descriptive and pragmatic, presenting a down-to-

earth look at how IT is actually practiced, rather than a theoretical treatise on optimal

monetary policy as it relates to IT. In that sense, it follows closely in the tradition of the

landmark study of Bernanke et al. (1999), as well as more recent survey papers such as

Mishkin and Schmidt-Hebbel (2002). But while the Bernanke et al. volume presented in-

depth case studies of seven inflation targeters (bITersQ), Truman’s grand tour includes all

22 central banks that had formally adopted IT at the time of writing. The case-study

approach is of course not feasible for this much-expanded club of ITers, but Truman

nonetheless manages to convey the range of ITers’ experience by a judicious grouping

into bmaintainersQ, seeking to keep inflation low; bconvergersQ, seeking marginal

inflation reductions; bsqueezersQ, seeking a significant reduction in inflation over the

long term; and breversersQ, seeking to increase inflation from undesirably low levels.

Because so many of the recent adopters of IT are emerging market or transition

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economies in the bconvergerQ or bsqueezerQ categories, the range of ITers’ experience

surveyed in the book is necessarily somewhat broader than that of Bernanke et al.

(1999).

A detailed statistical evaluation of ITers’ experience is presented in Chapter 3, which

deals with the macroeconomic effects of the policy framework. The analysis documents

the tendency for the introduction of IT to be associated with a statistically significant

reduction in the level of inflation, but not its overall volatility. This improvement in

inflation performance seems not to have come at the expense of output growth or

volatility, however, supporting the view that IT, as practiced, is bflexibleQ in the sense that

it does not prevent the central bank from responding to output fluctuations. While these are

important findings, IT’s potential effects extend well beyond the means and variances of

output and inflation. A more comprehensive analysis might also have considered more

subtle effects: on the persistence of inflation, for instance, as in Kuttner and Posen (2001),

or its predictability, as in Corbo et al. (2002). The policy’s beneficial effect of anchoring

inflation expectations, recently documented by Levin et al. (2004), is another important

empirical issue left unaddressed. So while Truman’s empirical results make a nice addition

to the accumulating evidence on IT’s macroeconomic effects, his is hardly the last word on

the topic.

Much of the book covers well-trod ground, although Truman performs an invaluable

service in bringing together and synthesizing the findings of a vast body of existing

research. The book does, however, cover two topics in some detail that do not normally

receive much attention in discussions of IT. The first is that of financial stability, the

subject of Chapter 6. While IT is not often linked to issues of financial architecture, there

may in fact be good reasons to do so: since the framework offers the promise of a resilient

nominal anchor, free of the brittleness of exchange-rate pegs, one might expect (or at least

hope) that the widespread adoption of IT would improve the stability of the international

financial system. Unfortunately, with most emerging market adopters having done so only

within the past 6 years, there is not much of a track record on which to base such a

conclusion; Truman nevertheless cogently argues that IT can be expected to lead to a more

stable international financial system. A related issue is the degree to which IT can be

accommodated within the IMF’s adjustment programs. On this, Truman notes that because

of its focus on macro outcomes IT is less readily amenable to close monitoring than, say,

money or exchange-rate-based policies. But he goes on to suggest that the transparency

and accountability associated with IT mean the IMF can afford to relax the terms of its

conditionality. It is on topics such as these that Truman is best able to bring to bear his

extensive experience as a close-range observer of the financial crises of the 1990s, and

their aftermath.

A second unique feature of the book is its extensive discussion of the relationship

between IT and exchange rate policy, the subject of Chapter 5. Truman highlights two

dimensions of this relationship. One is the impact of IT on the behavior of exchange rates,

which he explores with brief case studies of New Zealand, the UK, Sweden, Poland and

Brazil. It is hard to know what conclusions to draw from these exercises, however, perhaps

because Truman himself is not entirely clear about the sorts of effects one should be

looking for. All five countries’ exchange rates seem to exhibit the same kinds of anomalies

as non-ITers, leading him to the unsatisfyingly diffuse conclusions that bIT does not

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eliminate the potential for wide swings in exchange ratesQ and that ITers bneed to think

about movements in exchange rates and their impacts on the economyQ.The second aspect of the IT-exchange rate relationship covered in the chapter concerns

the co-existence of inflation and exchange rate targets. Here, Truman’s conclusion departs

from the conventional wisdom that only a free float, or something very close to it, is

compatible with IT; indeed, the inflation-targeting central banks of Chile and Israel have

both relaxed their exchange rate targets, to the point where both countries’ target bands

have become effectively irrelevant for monetary policy. Truman, however, is sympathetic

to a hybrid policy that supplements an inflation target with some form of exchange rate

management. Although the chapter discusses in some detail how such a scheme might

work, it neglects to spell out why, or under what conditions, such a policy might be

desirable; nor does it explain how the inevitable conflicts between the two objectives

should be handled, other than the vague prescription to defuse such conflicts before they

occur, or, if that fails, to exercise judgment.

If the book has a weakness, it is the cursory way in which it relates to macroeconomic

theory in general, and the principles of optimal monetary policy in particular—both

subjects of a great deal of recent research, such as that of Woodford (2003), Svensson

(1999) and Clarida et al. (1999), among others. Clearly, IT is characterized by many

institutional and practical details that would be hard, if not impossible, to incorporate

formally into a model, and most practitioners would no doubt object to Svensson’s (1999)

narrow characterization of IT as an optimal targeting rule. Nonetheless, the literature on

optimal monetary policy provides at least a useful starting point for understanding the

objectives of monetary policy and the rationale for IT.

The book does not completely ignore macroeconomic theory, but its occasional

allusions to it sometimes raise more questions than they answer. In summarizing the pros

and cons of IT, for example, Truman remarks that bthe case for inflation targeting is

grounded in the New Keynesian economics with its combination of forward-

looking. . .expectations and the incomplete nominal adjustment of pricesQ (p. 98).

Unfortunately, the reader is left to wonder why these particular features of the New

Keynesian theory are so critical to the IT case and what alternative policy framework

would be appropriate if one (or both) of these conditions failed to hold. The weakness of

the link to macro theory is perhaps one explanation for the lack of clarity with regard to the

role of exchange rates and the proper way to handle conflicts between exchange rate and

inflation objectives. Appealing to the findings of open-economy macro models might have

helped focus the exchange rate discussion, and at least provided a reference point for

understanding Truman’s more practically minded observations.

In the end, a balanced assessment of his own, and others’, evidence leads Truman to

conclude that bit may improve economic performance in many but not all cases, but the

evidence on this point is not fully conclusiveQ, and that the adoption of IT would not

bdistort policy priorities in the direction of fighting inflation excessively and neglecting

economic growthQ (p. 217). In other words, IT could not hurt and it may help. Clearly

Truman’s mission is not to sell IT—he is, as he says, a bsympathizer, not a proselytizerQ.And yet, Truman concludes with a more-or-less blanket endorsement of IT: not only for

the U.S. Federal Reserve, but also for the G3 collectively, and for emerging-market

economies, such as Argentina, Turkey and Russia. Chapter 4 even contains a detailed road

Book reviews 261

map for guiding the Federal Reserve, the European Central Bank and the Bank of Japan

towards its adoption.

Truman’s unqualified support might be surprising in view of his diffident summing-up

of the case for IT. What explains this is the high degree of adaptability that Truman sees as

inherent in IT; in fact, while cautioning against brandomized eclecticismQ, he encourages

potential adopters to experiment with and modify the framework as they see fit,

particularly in the area of exchange rate management. While purists might disown such

hybrid frameworks as something other than brealQ IT, his suggestion clearly has some

merit, and deserves consideration. Not only is Truman not a proselytizer, he is apparently

also not a fundamentalist.

References

Bernanke, B.S., Laubach, T., Mishkin, F.S., Posen, A.S., 1999. Inflation Targeting: Lessons from the International

Experience. Princeton University Press, Princeton NJ.

Clarida, R., Galı, J., Gertler, M., 1999. The science of monetary policy: a New Keynesian perspective. Journal of

Economic Literature 37, 1661–1707.

Corbo, V., Landerretche, O., Schmidt-Hebbel, K., 2002. Does inflation targeting make a difference? In: Loayza,

N., Soto, R. (Eds.), Inflation Targeting: Design Performance, Challenges. Central Bank of Chile, Santiago,

pp. 221–270.

Kuttner, K.N., Posen, A.S., 2001. Beyond bipolar: a three-dimensional assessment of monetary policy

frameworks. International Journal of Finance and Economics 6, 369–388.

Levin, A., Natalucci, F., Piger, J., 2004. The macroeconomic effects of inflation targeting. Federal Reserve Bank

of Saint Louis Review 86, 51–80.

Mishkin, F.S., Schmidt-Hebbel, K., 2002. A decade of inflation targeting in the world: what do we know and what

do we need to know? In: Loayza, N., Soto, R. (Eds.), Inflation Targeting: Design, Performance, Challenges.

Central Bank of Chile, Santiago, pp. 171–220.

Svensson, L.E.O., 1999. Inflation targeting as a monetary policy rule. Journal of Monetary Economics 43,

607–654.

Woodford, M., 2003. Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University

Press, Princeton NJ.

Kenneth N. Kuttner

Oberlin College, Economics Department,

Rice Hall, 10 North Professor Street,

Oberlin, OH 44074, United States

E-mail address: Kenneth.Kuttner@Oberlin.edu.

Tel.: +1 440 775 8592; fax: +1 440 775 6978.

doi:10.1016/j.jinteco.2004.10.002

Capital flows and crises

Barry Eichengreen, Capital Flows and Crises, MIT Press, 2003

This is an interesting book on a topical subject. The volume puts together previously

published papers by Barry Eichengreen, who brings his blend of historical expertise and

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