Introduction

The framework of (flexible) inflation targeting has been widely credited with facilitating, or even causing, the ‘Great Moderation’. In public perception, hubris has now been followed by nemesis – and the inflation-targeting framework is increasingly being blamed for the current financial crisis and the world recession. Many argue that the basis of monetary policy has to change – especially in the direction of giving more weight to asset prices in setting interest rates (see, for example, Wolf 2009). Common suggestions include the idea that the interest-rate-setting authorities should ‘lean against the wind’ of asset price movements, especially in the expansionary phase of a boom (Wadhwani 2008), or that the authorities should adopt a sufficiently long horizon that they can take asset prices into account within their mandate (see, for example, Bean 2003). Others call for a much more radical recasting of the objectives and procedures of monetary policy.

This chapter argues that the debate is in serious danger of going off track. The hubris, if hubris there was, arose not in thinking that interestrate-setting policy was vastly improved, but in believing that flexible inflation targeting was (in macroeconomic policy terms) all that was needed – that other aspects of macroeconomic and prudential policy could be neglected. Clearly, the success of inflation targeting allowed the fiscal authorities to disengage from the traditional macroeconomic concerns of inflation control and stabilisation. It also allowed the regulators to concentrate on micro-regulation (as the macroeconomic consequences of regulatory failure seemed to be someone else's responsibility).