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Ricardo Hausmann: Academic economists always want more evidence to support a claim, while policymakers have to make decisions in real time without the benefit of hindsight. One such decision is the choice of exchange and monetary arrangements in a changing world. Klaus Schmidt-Hebbel and Alejandro Werner have written a very good paper that stands in between these two extremes. They assess the performance of a relatively new approach to monetary policy in Latin America: inflation targeting. They perform a wide set of tests with relatively short datasets, and they address some of the controversies in the literature. Their main conclusion is that so far, so good. Inflation has been brought under control at relatively low cost, inflation targets are becoming more credible, and the targets tend to prevent price shocks from affecting core inflation. In this process, exchange rates are being allowed to fluctuate more freely, which would indicate that if a so-called fear of floating exists, it is waning.

One important question to ask is what exactly is inflation targeting in practical terms? In the tradition of Monsieur Jourdain in Molière's Tartuffe, it is easy to be excited by the knowledge that one speaks prose. By the same token, countries are waking up to the realization that they have been inflation targeting for some time, without knowing it. Chile and Mexico are two cases in point. Did Chile plan to adopt a gradual inflation targeting regime in 1990, or is that just a convenient way to tell the story ex post? What regime did Mexico adopt in early 1995? What regime have Argentina and Venezuela adopted in 2002? All central banks usually announce an inflation target. They may also announce other targets, however. For example, throughout much of the 1990s Chile and Colombia had the practice of announcing targets on anything that would move. They both had exchange rate target zones, while Chile also targeted the current account deficit and Colombia targeted money. It was never clear to market participants which target would dominate. Schmidt-Hebbel and Werner call this a gradual adoption of inflation targets. One could just as easily call it a target zone regime, which is how the authorities defined it at the time and also how Williamson describes it. ¹

If a country floats or has relatively wide bands, it has the capacity to control the money supply or the interest rate. It makes sense, in this context, to adjust policies so as to achieve certain targets. Since central banks are principally responsible for inflation, one would expect them to use their monetary flexibility to good purpose. It is therefore relatively easy to reinterpret all floating rate countries or countries with relatively wide exchange rate bands as being inflation targeters of sorts. As the paper even points out, the literature refers to the United States as an implicit inflation targeter, even though the Federal Reserve Board does not announce an inflation target and is well known to care about output and unemployment. To a large extent, inflation targeting is in the eye of the beholder.

A stricter definition would involve the absence of exchange rate commitments, that is, a floating regime relatively unencumbered by preannounced price targets, an inflation target that is obviously preeminent, and a monetary instrument that is periodically adjusted as a means to achieve that target. From this point of view, Chile can only be said to have been targeting inflation since the latter half of 1998, not 1990 as the paper states, given the country's exchange rate policy. In fact, Chile and Colombia should be classified as having had very similar policies during the 1990s, including the adoption of inflation targeting at the end of the decade, although the paper treats Colombia as a recent convert. Brazil clearly adopted inflation targeting in mid-1999, while Mexico is much harder to date, since it established monetary targets that it actually met and inflation targets that were missed by wide margins. The 1999 date used in the paper clearly was not obvious...