The first year of the eurosystem

nication is e?ective in motivating decisions, simplifying external evaluation and thereby improving transparency and accountability. I also consider whether the actual instrument setting has been appropriate, given the information available at the times of decision.

During the 1990s an increasing number of central banks have adopted in/ation tar- geting, which due to its logical and transparent design and apparent success so far has become a focus of interest and a natural frame of reference. In/ation targeting is char- acterized by, rst, an explicit numerical in/ation target. The in/ation target is pursued in the medium run, with due concern for avoiding real instability, for instance, in the output-gap; that is, in/ation targeting is is/exiblel; rather than ihstrict. l; Second, due to the unavoidable lags in the e?ects of instruments on in/ation, the decision framework is in practice irin/ation-forecast targetingl- (see below). Third, communication is very explicit and to the point; policy decisions are consistently motivated with reference to published in/ation and output (-gap) forecasts. Indeed, in/ation targeting has introduced unprece- dented transparency and accountability in monetary policy.

Three central banksSthe. Reserve Bank of New Zealand, the Bank of England, and Sweden(TM)s Sveriges RiksbankS stand out as particularly consistent and transparent in their implementation of in/ation targeting.

I. Goals The Maastricht Treaty assigns price stability as the primary objective for the Eu- rosystem but leaves to the Eurosystem the formulation of an operational de nition. In October 1998 the Eurosystem de ned price stability as isas a year-on-year increase in the Harmonised Index of Consumer Prices for the euro area of below 2%lo (ECB 1998a). It has several times emphasized the medium-term orientation of its policy and that a gradualist and measured response to threats to price stability will not introduce inunnecessary and possibly self-sustaining uncertainty into short-term interest rates or the real economy. le (ECB 1999). This emphasis on the medium term, gradualism, and stability of the real economy is consistent with ii/exiblel, rather than ihstrictll in/ation targeting.

However, as commentators quickly pointed out, the Eurosystem(TM)s de nition of price stability was ambiguous, since it did not specify a lower bound for in/ation. In November 1998 the ECB president, Willem Duisenberg (1998a), clari ed that the word i,Xincreasel?C should be interpreted as excluding de/ation. It would seem to follow that the lower bound was zero and that the de nition refers to an in/ation rate between 0 and 2%. However, two days later, Duisenberg (1998b) stated that ih[w]e did not announce a /oor for in/ation, because we know that the price index may include a measurement bias, but we do not know its magnitudel, . If the lower bound is zero, it would seem ...