Forefront in the Classroom :: Spring 2011

The Federal Reserve Bank of Cleveland’s policy publication, Forefront, is a great tool for generating topical class discussions. Read more (PDF)







President’s Message

In the President's message, Sandra Pianalto discusses the Federal Reserve's dual mandate and how important it is to have a clear, consistent objective. What is the Fed's dual mandate? Read more(PDF)

A Short History of Inflation Targeting at the Federal Reserve

Q & A with Marvin Goodfriend Read more (PDF)

The FOMC discussed the idea of adopting an explicit inflation objective in the 1990s, and the idea has resurfaced in the last year, with the Federal Reserve Bank of Cleveland’s President Sandra Pianalto calling for a numerical objective. Those discussions included Marvin Goodfriend, former research director of the Federal Reserve Bank of Richmond, who is in favor of an explicit inflation objective. What does Goodfriend give as the reason why the Federal Reserve hasn’t adopted an explicit inflation goal similar to those of several other central banks around the world?

Goodfriend said that the Fed may have been concerned about restricting its freedom of action. It could also be counterproductive not to follow through on a promise, so it might seem better not to promise anything in the first place. Moreover, some are concerned that the Fed cannot sustain inflation without higher unemployment.

What does Goodfriend say would occur, in theory, if the Federal Reserve fails to adopt an explicit inflation objective?

Price Stability: Why We Seek It and How Best to Achieve It

These questions are derived from the article and FAQ that also appeared in the Federal Reserve Bank of Cleveland’s 2010 annual report.

  1. The dual mandate: Why is price stability consistent with maximum employment?
    • Price stability can be thought of as an inflation rate low enough and predictable enough so that inflation does not enter prominently into the decisions of firms and consumers.
      The negative impact of high inflation can be broken down into four areas:
      • First, sustained high inflation erodes the purchasing power of people on fixed incomes.
      • Second, high inflation can lead consumers and firms to spend time and money managing its consequences. For example, consumers will devote more time tending to cash balances, and firms will change their posted prices more frequently.
      • Third, high inflation muddies the information on supply and demand that should be reflected in prices, leading to inefficient spending decisions.
      • Finally, because many components of federal and state tax codes are not indexed to the cost of living, high inflation creates adverse tax effects that can lead consumers and firms to take actions they would otherwise not take.
  2. What challenges does very low inflation create?
    • When inflation is very low, as it has been recently, the Federal Reserve’s ability to ease monetary policy is constrained if the federal funds rate cannot be reduced further. The experiences of Japan in the last two decades point to the real danger of low inflation—deflation, which occurs when the overall price level falls as inflation rates turn negative for extended periods. Sustained deflation can have serious negative effects on the real economy. When prices are expected to continue falling, consumers and firms will delay purchases while waiting for lower prices.
  3. How could a numerical objective for price stability help monetary policy?
    • The article mentions 3 major gains:
      • Better-anchored inflation expectations could increase the Fed’s ability to adjust monetary policy in order to stabilize the economy.
      • It could enhance the accountability and transparency of monetary policy: The public would know exactly what inflation outcome the FOMC was trying to achieve.
      • Putting a number on the inflation objective would help the FOMC explain its actions to the public.
  4. What countries have inflation targets, when did they adopted them, and what target (percent) did each establish?

    • CountryDateTarget (percent)

      New Zealand

      March 1990



      Feb. 1991


      United Kingdom

      Oct. 1992


      Czech Republic

      Jan. 1998


      Euro Area

      Jan. 1999



      June 1999



      Jan. 2001



      March 2001



      Jan. 2002



      Aug. 2005



      March 2006



      May 20078.5

How can inflation be considered low when food and gas prices are so high?

  1. What is the difference between inflation and relative price changes?
    • Inflation is a general rise in prices.
  2. Does inflation drive the relative price changes in gas and food that consumers have been seeing?
    • No, relative price changes are more likely driven by fundamental factors affecting supply and demand for particular goods. If you look at the price change for one item, such as gasoline (up 27 percent over the last year), it doesn’t say much about how high inflation is. Likewise, the decline in the price of infant and toddler apparel (down 3.8 percent in the past 12 months) does not indicate deflation.

Isn't pursuing a low and stable inflation rate going to cost the economy jobs?

  1. What is the effect of a low and stable inflation rate on the job market?
    • Low and stable inflation is an essential ingredient of job growth. It can help promote maximum employment by eliminating uncertainty about the evolution of monetary policy; it also allows relative prices to send clear signals to consumers.
  2. What occurs when monetary policy attempts to raise employment above a level consistent with stable inflation?
    • Consumers, businesses, and wage earners begin to anticipate the inflationary effects of the policy on all prices and wages. Producers of goods discover that they can increase their profit margins by raising prices at the cost of lower levels of output; therefore, they need fewer employees. Any tradeoff between inflation and unemployment eventually breaks down, resulting in permanently higher inflation but no lasting employment gains.

How do we know when people are worried about inflation?

  1. What tools are used to gauge public opinion on future inflation?
    One way is to ask people directly by way of surveys. The Reuters/University of Michigan Surveys of Consumers ask people how much they think prices will change in general terms, not relative to any statistics. Another way to quantify inflation expectations is the “break-even inflation rate” derived from the interest rates on two different types of Treasury securities.
  2. What method did the Federal Reserve of Cleveland develop to quantify inflation expectations?
    The FRBC developed a hybrid model that includes both financial data and survey measures of inflation to remove bias. It delivers a purer measure of inflation expectations and can also extract inflation expectations at a variety of time horizons.

Is an explicit inflation objective consistent with a dual mandate?

  1. How does the Reserve Bank of New Zealand’s strict inflation target operate?
    The RBNZ started pursuing a strict inflation target in 1990, with the sole purpose of price stability. It established a “hard” annual percent target range for its CPI:  0 to 2 percent.
  2. How does the Norges Bank (the central bank of Norway) operate its inflation target?
    The Norges Bank has been operating a “flexible inflation targeting regime” for the past 10 years. Its operational target is an annual CPI inflation rate of 2.5 percent over the medium term. Weight is given to stability in inflation, employment, and output, as in the Federal Reserve’s current dual mandate.