Stable International Monetary System Emerges: Inflation Targeting is Bretton Woods, Reversed
Andrew K. Rose*
Revised as of: November 15, 2006
"...Countries have a limited number of choices for their monetary strategy. Historically a large but declining number of countries have fixed their exchange rates. A number of countries have experimented with the idea of setting money growth targets. Some countries pursue hybrid or ill-defined strategies. And an increasing number of countries grant their central banks independence to pursue a domestic inflation target.
Inflation targeters let their exchange rates float, usually without controls on capital flows and often without intervention. Because the goal of monetary policy is aligned with national interests, inflation targeting seems remarkably durable, especially by way of contrast with the alternatives. It is striking that no country has ever been forced to abandon an inflation-targeting regime. But the domestic focus of inflation targeting does not seem to have observable international costs. Countries that target inflation experience lower exchange rate volatility and fewer “sudden stops” of capital flows than their counterparts; nor do they have different current accounts imbalances, or reserve levels.
As a result of its manifest success, inflation targeting has continued to spread; it now includes a number of developing countries as well as a large chunk of the OECD. Indeed the spread of this monetary strategy has been remarkably fast in the conservative world of monetary policy. The system of domestically-oriented monetary policy with floating exchange rates and capital mobility was not formally planned. It does not have a central role for the United States, gold, or the International Monetary Fund. In short, it is the diametric opposite of the postwar system; Bretton Woods, reversed.
Sustainability is currently the biggest policy issue in international monetary affairs. There is much heated discussion over global imbalances and the Chinese-American exchange rate; is there a “revived” Bretton Woods system? In the midst of this debate, we should not lose sight of the resilience and stability of the emerging international monetary system, which can be accurately described as “Bretton Woods, reversed.”...