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Abstract
In the early 1990s, Canada was one of several countries to adopt an inflation-targeting framework for monetary policy. A noted exception to this group was the United States, where the framework for monetary policy was, as it had been for some time, informed by a dual mandate to maintain both high employment and low and stable inflation. By the late 1990s, the United States seemed to settle, in effect, on an implicit inflation-targeting framework for monetary policy. Nevertheless, whether the preferences of each central bank actually shifted toward minimizing inflation variability, and whether the magnitudes, opportunity costs, and timing of any such shifts were the same for both economies are questions that remain largely unexplored. In this article, I estimate these preferences from 1970 to 2009. Taken together, my results indicate that the Bank of Canada was more inflation averse overall; and both central banks grew more inflation averse over time.
Notes
1. The timetable identified inflation-target midpoints of 3 percent by the end of 1992, 2.5 percent by the middle of 1994, and 2 percent by the end of 1995 (Bernanke et al. Citation1999).
2. It likely achieved both outcomes early on (Miron Citation1996, 145–6).
3. To operate a central bank on the gold standard was to follow the so-called rules of the game: permit the money stock to expand (contract) when gold flowed into (out of) the country.
4. Most countries—crucially, Britain, France, and Germany—left the gold standard during the First World War; most returned to it, often at or near prewar parities, soon thereafter (Eichengreen Citation1992, 101)
5. As policies that, in effect, determined the supply of money during the interwar period, the gold standard and the real-bills doctrine were “of course contradictory” (Friedman and Schwartz Citation1963, 191).
6. Wartime inflation and the breakdown of the international gold standard during and after the First World War inspired similar debates about price-stability mandates, though legislation to this effect never materialized. Meltzer (Citation2003, 192) writes: “It is an understatement to say that this was a missed opportunity. If the mandate for price stability had been passed and followed, the Federal Reserve could not have permitted deflation during the Great Depression of 1929–33 or inflation during the Great Inflation of 1965–80.”
7. Meanwhile, the government imposed wage-and-price controls from 1942 to 1946.
8. The accord granted the central bank independence “within the government” (Meltzer Citation2003, 713) and, in doing so, “[took] its place alongside the Banking Act of 1935 as one of the monumental events in the history of the modern Federal Reserve System” (Bremner Citation2004, 79).
9. Even then, consumer-price inflation reached 6 percent in 1950 and topped 10 percent in 1951; it returned to near 0 percent by 1953 and the end of the Korea War (Bordo et al. Citation2007, 10).
10. The 1960s ushered the seminal contributions of the (Canadian) economist, Robert Mundell, whose work in this area was inspired by the Canadian experience in the 1950s.
11. The variability of output measures the mean squared deviation of (log) output from trend, which I use the Hodrick-Prescott filter to estimate over the entire sample, 1970–2009. Because the variance of output effectively scales the estimate of (α), other estimation techniques simply changed—and, in most cases, raised—the estimate for both economies. The variability of inflation measures the mean squared deviation of inflation from 2 percent rather than, say, average inflation during the period. Because the average necessarily minimizes the variance statistic, estimates of α based on average inflation are necessarily greater than or equal to estimates based on a specific target such as 2 percent.
12. In contrast, the central bank can simultaneously offset aggregate demand shocks to output and inflation.
13. The derivation appears in the Appendix.
14. Estimates of the so-called sacrifice ratio—the cumulative percentage-point loss in output over three years that is attributable to a policy-induced one-percent-point permanent reduction in the inflation rate—are 6.76 and 5.95 for Canada and the United States, respectively. These estimates are consistent with those for γ: all else equal, a relatively flat supply curve should yield a relatively large sacrifice ratio. The results are also broadly consistent with those in the extant literature [See for example, Ball (Citation19942) for Canada and the United States and Cecchetti and Rich (Citation2001) for the United States, only]. In theory, a nominal anchor such a an inflation target should reduce the output costs of disinflation in the short run because the economy's wage-and-price structures should respond to the central bank's credible commitment to price stability. Nevertheless, most countries that have adopted an inflation-targeting framework have failed to alter their short-run output-inflation tradeoffs (Bernanke et al. Citation1999, 280).
15. According to Laidler and Robson (Citation2004), “The sources and significance of this rise [in inflation] were, and remain, matters of some controversy.