Early proposals of monetary systems targeting the price level or the inflation rate, rather than the exchange rate, followed the general crisis of the gold standard after World War I. Irving Fisher proposed a "compensated dollar" system in which the gold content in paper money would vary with the price of goods in terms of gold, so that the price level in terms of paper money would stay fixed. Fisher's proposal was a first attempt to target prices while retaining the automatic functioning of the gold standard. In his Tract on Monetary Reform (1923), John Maynard Keynes advocated what we would now call an inflation targeting scheme. In the context of sudden inflations and deflations in the international economy right after World War I, Keynes recommended a policy of exchange rate flexibility, appreciating the currency as a response to international inflation and depreciating it when there are international deflationary forces, so that internal prices remained more or less stable.
Interest in inflation targeting schemes waned during the Bretton Woods system (1944-1971), as they are normally inconsistent with exchange rate pegs such as those prevailing during three decades after World War II (...)
A more essential objection to the strategy of inflation targeting is that it doesn't really comprise a specific set of monetary policy recommendations -as traditional monetarism, for example, did- but constitutes just an explicit statement of the aims of the monetary authority. Since the mid-1990s there have been theoretical attempts to add substance to inflation targeting by proposing explicit monetary rules which could lead to a low and stable inflation rate. One such proposal involves Central Bank intervention in the futures market for the CPI at predefined prices: if prices are expected to exceed the target, speculators would buy future contracts to the Central Bank at the preset prices, thus reducing the money supply until it reaches a level compatible with the target. Another proposal consists in fixing a band for Central Bank intervention in the CPI-indexed bond market. The Central Bank commits itself to to selling (buying) unlimited amounts of indexed bonds whenever inflationary expectations, as measured by the difference between the non-indexed and the indexed bonds, exceed (are short of) the inflation target. Such an intervention would imply an automatic increase in the money supply whenever inflation expectations are below the target and an automatic fall in the money supply if inflation expectations exceed the target. Necessarily, the level of the money supply will always stand at a range that market participants consider compatible with the attainement of the inflation target.
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