Flexible Inflation Targeting

11 Key excerpts on "Flexible Inflation Targeting"

• 

  eBook - ePub

  Handbook of Monetary Economics vols 3A+3B Set

  • Benjamin M. Friedman, Michael Woodford(Authors)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  Monetary Economics , Vol. Suppl., No. 2011

  ISSN: 1573-4498

  doi: 10.1016/B978-0-444-53454-5.00010-4

  Chapter 22 Inflation Targeting*

  Lars E.O. Svensson, Sveriges Riksbank and Stockholm University

  Abstract Abstract

  Inflation targeting is a monetary-policy strategy characterized by an announced numerical inflation target, an implementation of monetary policy that gives a major role to an inflation forecast that has been called forecast targeting, and a high degree of transparency and accountability. It was introduced in New Zealand in 1990, has been very successful in terms of stabilizing both inflation and the real economy, and as of 2010 has been adopted by about 25 industrialized and emerging-market economies. This chapter discusses the history, macroeconomic effects, theory, practice, and future of inflation targeting.

  JEL classification E52 E58 E42 E43 E47

  Keywords Flexible Inflation Targeting Forecast Targeting Optimal Monetary Policy Transparency

  1 Introduction

  Inflation targeting is a monetary-policy strategy that was introduced in New Zealand in 1990. It has been very successful, and as of 2010 had been adopted by approximately 25 industrialized and nonindustrialized countries. It is characterized by (1) an announced numerical inflation target, (2) an implementation of monetary policy that gives a major role to an inflation forecast and has been called forecast targeting, and (3) a high degree of transparency and accountability (Svensson, 2008

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Handbook of Monetary Economics

  • Benjamin M. Friedman, Michael Woodford(Authors)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  Importantly, there is no evidence that inflation targeting has been detrimental to growth, productivity, employment, or other measures of economic performance in either developed and developing economies. Inflation targeting has stabilized long-run inflation expectations. No country has abandoned inflation targeting after adopting it (except to join the Euro Area), or even expressed any regrets. For both industrial and non-industrial countries, inflation targeting has proved to be a most flexible and resilient monetary-policy regime, and has succeeded in surviving a number of large shocks and disturbances, including the recent financial crisis and deep recession. 15 The success is both absolute and relative to alternative monetary-policy strategies, such as exchange-rate targeting or money-growth targeting. 3 THEORY As mentioned earlier, in practice, inflation targeting is never “strict” but always “flexible,” in the sense that all inflation-targeting central banks not only aim at stabilizing inflation around the inflation target but also put some weight on stabilizing the real economy; for instance, implicitly or explicitly stabilizing a measure of resource utilization such as the output gap between actual output and potential output. Thus, the target variables of the central bank include not only inflation but other variables as well, such as the output gap. The objectives under Flexible Inflation Targeting seem well approximated by a quadratic loss function consisting of the sum of the squared inflation deviation from target and a weight times the squared output gap, and possibly also a weight times the squared policy-rate change (the last part corresponding to a preference for interest-rate smoothing). Because there is a lag between monetary-policy actions (such as a policy-rate change) and its impact on the central bank’s target variables, monetary policy is more effective if it is guided by forecasts

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Inflation Targeting

  Lessons from the International Experience

  • Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin, Adam S. Posen(Authors)
  • 2018(Publication Date)
  • Princeton University Press

    (Publisher)

  Japan has recently announced its intention to adopt inflation targets. Moreover, most o f the elements o f inflation targeting can be f o u n d i n the long-standing and well-regarded monetary policy o f Germany and Switzerland. 1 I n the U n i t e d States, inflation tar- geting has attracted some influential advocates, both w i t h i n and outside the Federal Reserve System. For example, a b i l l introduced by Congress- m a n B i l l Saxton ("The Price Stability Act o f 1997") calls explicitly for the use o f inflation targets by the Fed. 2 Finally, the Maastricht Treaty, the basis for the proposed European monetary u n i o n , mandates price sta- bility as the primary objective o f the new European Central Bank. The European Monetary Institute has stated that "the list o f potential candi- date strategies [for the future ECB] has been narrowed down to two, namely monetary targeting and direct inflation targeting." 3 What Is Inflation Targeting? Inflation targeting is a framework for monetary policy characterized by the public announcement o f official quantitative targets (or target ranges) for the inflation rate over one or more time horizons, and by explicit ac- knowledgment that low, stable inflation is monetary policy's primary long- r u n goal. A m o n g other important features o f inflation targeting are vigor- ous efforts to communicate with the public about the plans and objectives o f the monetary authorities, and, i n many cases, mechanisms that strengthen the central bank's accountability for attaining those objectives. A Framework, Not a Rule A principle theme o f this book is that, i n practice, inflation targeting serves as a framework for monetary policy rather than as a rule for m o n - etary policy. This distinction requires a bit o f explanation.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  21st Century Economics: A Reference Handbook

  • Rhona C. Free(Author)
  • 2010(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  3 7 MONETARY POLICY AND INFLATION TARGETING PAVEL S. KAPINOS Carleton College DAVID WICZER University of Minnesota I nflation targeting (IT) is a framework for the conduct of monetary policy, under which the monetary authority announces a medium- or long-run inflation target and then uses all available information to set its policy instrument, the short-term nominal interest rate, so that this target is met. Short-lived deviations from the inflationary target may be acceptable, especially when there may be a short-run trade-off between meeting the target and another welfare consideration, for example, the output gap—the difference between actual and potential output. Hence, although the central bank commits to meeting a certain inflationary target, in practice, IT takes a less rigid form, with the central bank exercising some discretion over the path of actual inflation toward its tar-get. Recently, dozens of central banks around the world have introduced IT as their operational paradigm. Numerous studies indicate that this policy has been suc-cessful in achieving macroeconomic stability at no long-run cost in terms of lower real activity. Many central banks that have not explicitly subscribed to IT have been shown to follow it implicitly. IT provides a way for the central bank to communicate its intentions to the public in a clear, unequivocal manner, making the conduct of monetary policy more transparent and predictable. Transparency allows the public to hold the central bank accountable for its policy actions. In fact, in some countries, inflation-targeting central banks are subject to intense public scrutiny from the legislative bodies. Predictability of monetary policy allows the cen-tral bank to manage public inflationary expectations and better anchor them around the inflationary target; this allows the central bank to achieve macroeconomic stabil-ity more effectively.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Inflation Targeting and Central Banks

  Institutional Set-ups and Monetary Policy Effectiveness

  • Joanna Niedźwiedzińska(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  Of course, deciding at which point a change already means a new regime is difficult, in particular when analysing inflation targeting, since this strategy from the very beginning has been continuously evolving (Niedźwiedzińska et al., 2019, pp. 42–72). Given the fact that in the 1990s, IT was tried as a pragmatic solution to the problem of heightened inflation without deep theoretical foundations, and only after proving to be quite successful and gaining popularity which motivated economists to look for reasons behind its effectiveness, this constant evolution should not be surprising. Apart from that, when adopting the framework, many inflation targeters were testing some innovative solutions that sometimes turned out to be beneficial and sometimes were abandoned (Ciżkowicz-Pękała et al., 2019, pp. 73–181). For that reasons, although key IT features are commonly known, they are defined in quite general terms and leave room for various interpretations. Indeed, the past three decades have shown that flexibility should be viewed as one of the important aspects of an inflation targeting regime.

  Although sometimes it may not be easy to decide what can and what cannot be treated as compatible with IT, some proposals for reforming the currently used monetary policy frameworks clearly do not violate inflation targeting constituting features. Raising inflation targets is definitely one of them (Blanchard et al., 2010; Ball, 2014).77 Despite not enjoying much support among central bankers (Bernanke, 2019, p. 5), not least due to its likely inconsistency with the mandate of price stability, the idea of increasing the targeted level of inflation in advanced economies from the most typical 2% to 4% has recently been proposed again (Posen, 2019, pp. 68–69).78 Its key benefit would be to provide more space for lowering nominal interest rates before reaching the ZLB.

  At the same time, recognising the fact that inflation targeting was introduced as a framework to fight too high inflation, some economists have raised doubts about whether it can be equally suitable for fighting too low price growth, which would suggest the need to go beyond IT (Heise, 2019, p. 77). Thus, a number of alternative targeting rules have been proposed. Similarly to the case of raising inflation targets, their main motivation is to deal with the problem of the ZLB.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Monetary Policy, Capital Flows and Exchange Rates

  Essays in Memory of Maxwell Fry

  • William Allen, David Dickinson(Authors)
  • 2002(Publication Date)
  • Taylor & Francis

    (Publisher)

  During the quarter-century since then, the rate of inflation has been reduced tenfold, from over 25 per cent to below 2.5 per cent. The fall in the rate of inflation has not been steady or continuous. There have been a number of crises, and a number of different monetary policy techniques have been used. Inflation targeting is the latest of them, adopted after the United Kingdom left the European Exchange Rate Mechanism, and it has been the longest-lasting. The procedures of inflation targeting are still evolving in the light of continuous learning through experience.

  Inflation targeting is based on the assumption that low inflation is the single proper objective of monetary policy. That assumption is based, in the United Kingdom, on the unhappy experience of trying to pursue other objectives with monetary policy. It is beyond the scope of this paper to justify the assumption that price stability should be the proper objective of monetary policy. Briault (1995) sets out the arguments: the public debate in the United Kingdom has become much less heated in the last few years, perhaps largely because low inflation has been accompanied during those years by strong economic growth and falling unemployment, so that there has been no sign of a conflict between low inflation, high growth and high employment.

  Nevertheless, there have been some complaints in the United Kingdom that the fact that the central bank is pursuing an inflation target means that it is not concerned about output and employment. This is a misconception, because the inflation target is symmetrical. It is just as serious a policy error for inflation to be below target as it is for it to be above target, and if inflation is expected to be below target, it is the Bank of England’s duty to ease monetary policy. Moreover, the Bank of England is required by law to support the Government’s economic policy, including its objectives for growth and employment, subject to the overriding objective of maintaining price stability.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Handbook of Monetary Policy

  • Jack Rabin(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Conducting Monetary Policy with Inflation Targets

  George A. Kahn

  Vice President and Economist, Federal Reserve Bank of Kansas City, Kansas City, Missouri

  Klara Parrish

  Assistant Economist, Federal Reserve Bank of Kansas City, Kansas City, Missouri

  Reprinted from: Federal Reserve Bank of Kansas City Economic Review, v. 83, n. 3 (Third Quarter 1998) 5–32.

  Since the early 1990s, a number of central banks have adopted numerical inflation targets as a guide for monetary policy. The targets are intended to help central banks achieve and maintain price stability by specifying an explicit goal for monetary policy based on a given time path for a particular measure of inflation. In some cases the targets are expressed as a range for inflation over time, while in other cases they are expressed as a path for the inflation rate itself. The measure of inflation that is targeted varies but is typically a broad measure of prices, such as a consumer or retail price index.

  At a conceptual level, adopting inflation targets may necessitate fundamental changes in the way monetary policy responds to economic conditions. For example, inflation targeting requires a highly forward looking monetary policy. Given lags in the effects of monetary policy on inflation, central banks seeking to achieve a target for inflation need to forecast inflation and adjust policy in response to projected deviations of inflation from target. But central banks without an explicit inflation target may also be forward looking and equally focused on a long-run goal of price stability. Thus, at a practical level, adopting inflation targets may only formalize a strategy for policy that was already more or less in place. If so, targets might improve the transparency, accountability, and credibility of monetary policy but have little or no impact on the way policy instruments are adjusted to incoming information about the economy.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Central Bank Policy

  Theory and Practice

  • Perry Warjiyo, Solikin M. Juhro(Authors)
  • 2019(Publication Date)
  • Emerald Publishing Limited

    (Publisher)

  (1) In the near term and with maintained macroeconomic stability, there can be a potential shift in the focus of monetary policy toward greater emphasis on economic growth. This fundamentally confirms the idea that achieving price stability as the overriding goal does not imply that the central bank can neglect efforts to maintain economic growth momentum. In contrast, in the near term, the preference of monetary policy can be oriented toward specific considerations that maintain the economic recovery process, while striving toward price stability in the long term as a prerequisite for sustainable economic growth.

  (2) Congruent with some of the lessons garnered from the GFC, a more flexible monetary policy response is required when considering the strategic role and dynamics of the financial sector. To that end, an optimal and effective monetary and macroprudential policy instrument mix is required. Despite the need for greater consideration of the strategic role and dynamics of the financial sector, the strategic monetary policy framework in Indonesia maintains price stability as the main factor underlying the monetary policy response.

  (3) In terms of policy implementation, flexibility also contains institutional aspects considering that the root of the problems faced by the central bank is not always within the scope of monetary policy influence. Therefore, strong policy coordination between BI and the Government is imperative.

  It should be reiterated that, in the context of ITF implementation, BI already implicitly applies Flexible ITF, meaning that in the near term, BI strives to stabilize inflation and the real economy together. ITF flexibility is reflected in the orientation to achieve the overriding goal, namely inflation, but while also paying due consideration to the dynamic performance of other macroeconomic variables in the short term, such as economic growth, exchange rates, and financial sector developments. To that end, five important factors are always considered when determining the policy rate, namely: (1) the two-year inflation forecast and consistency with the inflation target; (2) the two-year economic growth forecast; (3) the exchange rate forecast and affecting factors (including capital flows), as well the impact on the inflation and economic growth forecasts; (4) bank credit and interest rates; and (5) asset valuation in the financial sector. The first two factors maintain BI Rate consistency with attainment of the inflation target, while considering the inflation-growth trade-off to maximize public welfare. The final three factors balance monetary stability and financial system stability, while also assessing the monetary policy transmission mechanism.

  Sign up to read

  Learn more about book
• 

  No longer available |Learn more

  Inflation Targeting in the World Economy

  • Edwin M. Truman(Author)
  • 2003(Publication Date)
  • Peterson Institute for International Economics

    (Publisher)

  The focus of this study is inflation targeting in the world economy and how applicable the monetary policy framework is to a broad range of countries. From this perspective, the principal question is the role infla-tion targeting plays on average in overall economic performance includ-ing the trade-offs between inflation and growth and between the vari-ability of inflation and the variability of growth. Also of interest is the question of whether one can identify structural features associated with the economies of some potential inflation targeters—for example, their external environments—that suggest inflation targeting in general is contra-indicated as a framework for monetary policy. Specifically, the following questions are examined: 1. What factors are strongly associated with the level and variability of inflation? 2. Can one detect an influence of inflation targeting in general on the level or variability of inflation? 3. Can one detect an influence of inflation targeting in general on the level or variability of growth? 4. What light can be shed on the question of the external circumstances or vulnerability of countries that suggest inflation targeting may be more or less successful for them in general as their framework for monetary policy? 5. Is there evidence that countries that have adopted inflation targeting on average have achieved lower inflation at the expense of lower growth (moved along the Phillips Curve) and lower inflation variabil- ity at the expense of higher growth variability (moved along the Taylor Curve relating those two variables), as skeptics have suggested? 6.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Frontiers of Heterodox Macroeconomics

  • Philip Arestis, Malcolm Sawyer, Philip Arestis, Malcolm Sawyer(Authors)
  • 2019(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The idea of higher nominal-GDP rates together with low interest rates should accelerate GDP growth further and the inflation target, which is still in place, is reached after a recession. This means that inflation target in the long run maintains its pre-set level, but in the short run the nominal-GDP target is put in place instead of the Taylor rule (Frankel 2013, p. 93). 3.1.1 Add-Ons to the System of Inflation Targeting The question on how important monitoring of asset price developments by central banks to conduct monetary policy should be is discussed after the financial crisis. While some proposals argue in line with a ‘Flexible Inflation Targeting’ mechanism (Woodford 2012), others aim to introduce additional measures to enlarge the scope of inflation targeting and already derived macroprudential proposals. The latter aim to figure out, whether in the respective national banking sector bottlenecks can be detected, which might lead to low interest rates that are not spread beyond the banking sector. This means that the monetary authority has to ‘think beyond a simple Taylor rule’ (Brunnermeier and Sannikov 2013, p. 98). Similar to forms of reshaping goals of inflation targeting schemes, also an increase of the focus to prudential measures increase the ‘flexibility of the system’ of inflation targeting and aim to respond in the short term with a broader set of instruments (Banerjee et al. 2013, p. 117). It was also noted that this additional claim for greater financial stability, which is beyond a traditional view of a sound financial system but aims to provide a tool against financial crisis, implies that there might arise a gap in the medium-run to the respective target (inflation and/or nominal-GDP target). All in all the developments after the financial crisis ask for minor changes in the modelling but do not aim to reframe its fundamentals

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Money and Payments in Theory and Practice

  • Sergio Rossi(Author)
  • 2007(Publication Date)
  • Taylor & Francis

    (Publisher)

  The theory of inflation targeting is a result of the long-lasting ‘rules versus discretion’ debate in monetary policy, which more recently gave rise also to the calls for central bank independence. This debate is at least 200 years old and could be traced back to the controversy between the banking and currency schools that broke out at the beginning of the nineteenth century over the constitution of the Bank of England (see e.g. Fetter 1965). It has also been an issue during the twentieth century, as Keynes’s (1932) and Simons’s (1936) argument testifies well before the Kydland and Prescott (1977) seminal contribution led to today’s central bank independence as an improved version of the rule-based approach to monetary policy argued, for instance, by Friedman (1968).

  In fact, inflation targeting is not a rule, as it does not provide a simple and mechanical framework for the conduct of monetary policy. Quite to the contrary, it requires monetary policy makers to use structural models of the economy as well as their own judgement, and to consider all available information to design the policy that is more likely to hit the target rate of inflation and be conducive to good economic performance. This allows indeed some discretion to monetary policy makers. Inflation targeting may be defined therefore as ‘a framework for policy within which “constrained discretion” can be exercised’ (Bernanke et al. 1999: 22). This makes it a good compromise for both advocates of policy rules and partisans of policy discretion. As Bernanke et al. (1999: 6) point out, ‘[b]y imposing a conceptual structure and its inherent discipline on the central bank, but without eliminating all flexibility, inflation targeting combines some of the advantages traditionally ascribed to rules with those ascribed to discretion.’

  Now, critics of inflation targeting often argue that both the ineffectiveness and the rather weak economic performance of this regime is the direct result of a hierarchical mandate attributed to inflation-targeting central banks (see, notably, Meyer 2002, Bernanke 2003). According to these authors, a dual mandate allows monetary policy to contribute to lowering output variability without thereby putting the price stability goal at stake. In fact, the problem of inflationtargeting regimes is not merely institutional, but analytical essentially. To be sure, even with a dual mandate attributing equal footing to output and price level stability, the problem remains that a symptom-based definition of inflation cannot help going to the root of this phenomenon to get rid of it eventually. Clearly, the problem is not merely that a central bank’s policy success is currently established on its ability to meet inflation targets rather than output growth targets, as Arestis and Sawyer (2003: 5) maintain. Even if one were to succeed in changing the political criteria by means of which monetary policy is both designed and assessed today, one could still not make sure that central banks contribute to economic performance according to the social preferences as regards inflation and output outcomes.

  Sign up to read

  Learn more about book