Friday, August 21, 2009

Who's the best at targeting inflation?

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
Second: ECB
(Distant) Third: Fed

Rebecca Wilder


  1. Rebecca, any reason for the truncated sample ? Didnt Australia and NZ also have inflation targeting system ?

  2. Hi Paul,

    Alas, you caught me. Slight laziness is the answer. The Bloomberg inflation numbers are for the EU15, which is now the Euro area (16). At any rate, the EU16 numbers (from eurostat) are 2007 annual inflation = 2.1 and 2008 annual inflation = 3.3.

    You are correct - Australia (2%-3%) and New Zealand (1%-3%).

    Thanks for stopping by! Rebecca

  3. Rebecca,

    Sorry to interject with a comment on the previous post.

    Here's a chart of services PCE. I see why you say its "stable" -- not declining. What that masks is that with healthcare services growing, something is likely shrinking in order for the growth rate to collapse as it has. Given negative trends in personal income, I would be surprised if PCE services did not fall year over year by next month. Further, I would say that looking at the last 20 years, the growth rate of PCE services has been relatively stable. Something is clearly different now. Also note that the ratio of (or spread between) ISM services to ISM seems to have been out of whack recently -- I don't have a chart, but I'd love to see it.

    BTW, given the contraction in services employment, its a wonder the services PCE growth rate is still positive! I suspect there is some sort of statistical tomfoolery involved -- imputed spending on services maybe? Owners equivalent rent? I'm not sure how spending on existing housing is treated in the PCE data.

  4. Not only authorities should think through the economic process and find solution for the crisis. The citizens should also be aware of what inflation rate is and how it might affect them.

  5. Anyway, the FED is the one who has to make the right decisions .

  6. I'm not sure what "annual inflation rate" means in practice. There are several ways to measure inflation. The Fed seems to be targeting the core PCE deflator and has done a pretty good job. It's a good thing the Fed wasn't targeting headline inflation, or it would have gotten too tight at just the wrong time. If the others are targeting headline inflation, there's no easy way to compare them.

  7. Hi Andy,

    I think that I hit return too quickly, but here we go again.

    It's a good point, and a better analysis would have included headling PCE rather than CPI.

    I use the CPI measure, since it is a more or less consistent measure of inflation across the economies - not to mention that other central banks actually use the CPI to gauge the target.

    The Fed's announced target is regarding headline PCE, rather than the core (although, it is commonly understood that the Fed focuses on core PCE).

    Headline PCE is still out of range, 2.9% on average over the last 5 years, and converging closer to target over the longer term, 2.3% since 1992. Go back to 1985, and the average grows to 2.7%.

    Thanks for the comment! Rebecca

  8. Well, a projection is not quite the same thing as a target. (I had a post about that in my own blog a few months ago, though it may not be relevant here.) I think I'm being consistent with the usual practice in interpreting the headline projections as core targets (under the assumption that the Fed is projecting that real food and energy prices will be constant and doesn't care much about missing that projection).

    Actually, the Fed only recently started issuing long-range projections, so technically, those projections don't apply to the period on your chart. We can't really hold the Fed responsible for missing non-targets that it never even issued in the first place.

  9. Hi Andy,

    Touche - a projection is not a target! In the release (link above), it was very timely (right in the midst of deflationary fears) how the Fed highlighted its central tendency so ostensibly like a target. I wouldn't be surprised if the Fed moved to an inflation target if Bernanke remains Chair - what do you think?

    But truth be told, the Fed has no target, so it is unfair to treat it as such. Nevertheless, inflation averages something higher than 1.75%-2%.