Friday, August 21, 2009
The Bank of Canada, Bank of England, and European Central Bank set short-term rates in order to achieve a medium-term inflation target of around 2%: 1%-3% at the BoC, 2% at the BoE, and 2% at the ECB. The Fed, although it has no such target explicitly listed in as a policy objective (its mandate is to promote high employment, stable prices, and moderate long-term interest rates), has listed the “central tendency” of the FOMC’s inflation projection, i.e., what the Committee would deem a target; that central tendency is 1.7-2.0%. Sounds reasonable, right? Probably not, given its history.
The chart illustrates the annual inflation rate in the US, UK, Canada, and across the Eurozone 15 countries. The series are volatile, so I included a polynomial trend line for clarification.
In the last five years, the US annual inflation rate averaged 3.0%. And over a longer period, 1992-2008, the annual inflation rate averaged 2.5%. Accordingly, the Fed does not regularly meet this “target” (unless productivity dropped inflation, like it did in the early 2000’s). But the BoC and the UK are very good at targeting inflation, with average annual inflation equal to 1.86% and 1.96%, respectively, spanning the years 1992-2008. On the other hand, the EU (15) – admittedly, the data is truncated at 2006 but the ranking still holds if average rates are compared through 2006 – missed its target by 0.2% (2.2% average annual inflation rate).
So who's the best at targeting inflation? Here’s the ranking, with a tie for first place:
First: BoC and BoE
(Distant) Third: Fed