Inflation Targeting in New Zealand

12 Key excerpts on "Inflation Targeting in New Zealand"

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  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

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  eBook - ePub

  Handbook of Monetary Economics

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

    (Publisher)

  Chapter 22

  Inflation Targeting

  Lars E.O. Svensson    Sveriges Riksbank and Stockholm University

  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

  Contents

  1.  Introduction 

    1238

  1.1  An announced numerical inflation target 

    1239

  1.2  Forecast targeting 

    1239

  1.3  A high degree of transparency and accountability 

    1240

  1.4  Outline 

    1241

  2.  History and Macroeconomic Effects 

    1242

  2.1  History 

    1243

  2.2  Macroeconomic effects 

    1244

  2.2.1  

  Inflation  

    1246

  2.2.2  

  Inflation expectations  

    1247

  2.2.3  

  Output  

    1248

  2.2.4  

  Summary of effects of inflation targeting  

    1249

  3.  Theory 

    1250

  3.1  A linear–quadratic model of optimal monetary policy 

    1252

  3.2  The projection model and the feasible set of projections 

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  Inflation Targeting and Central Banks

  Institutional Set-ups and Monetary Policy Effectiveness

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

    (Publisher)

  Chapter 1 shows that an inflation targeting framework evolved from a pragmatic solution applied in one country in specific circumstances to combat elevated inflation, into a fully fledged monetary policy strategy that, in fact, turned out to be highly flexible. Consequently, inflation targeting has become a dominant regime among big and medium-sized countries.

  Inflation targeting incorporates the main conclusions drawn from monetary economics, namely, that there is no long-run trade-off between output and inflation, and that inflation is associated with costs. It also takes into account the role of expectations and the need to use a strong nominal anchor when conducting policies. Within this regime, monetary policy is thought of as a way to stabilise the economy, predominantly by maintaining price stability, but with a preference also for minimising output fluctuations. Thus, it is often stressed that central banks follow a flexible inflation targeting framework, as opposed to strict inflation targeting where monetary authorities would care only for meeting an inflation target, independently of the high costs it would cause.

  Looking at elements constituting an inflation targeting strategy, these include clear priority for price stability as a monetary policy objective, public announcement of an inflation target, conducting monetary policy based on a wide range of information, and fulfilling high accountability and transparency requirements, which complement the significant independence granted to monetary authorities. More generally, an IT framework is based on using certain instruments in order to meet specific targets, although it cannot be treated as a simple prescription of predetermined actions needed to reach the final objectives.

  It seems that the key feature that makes inflation targeting so compelling to many countries, is that, in practice, it proposes a reasonable balance between inflation and output stabilisation, without, however, sacrificing central banks’ credibility. From another perspective, it can also be seen as a compromise between a policy conducted according to rules and a policy allowing for discretion, which is possible owing to the emphasis placed on accountability and transparency within that framework. For these reasons, the notion of constrained discretion appears to be the best way to describe the essence of an IT strategy.

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  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.

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  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.

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  Money and Payments in Theory and Practice

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

    (Publisher)

  5 Monetary policy strategies

  Monetary policy strategies around the world are increasingly centred on attaining some targeted rate of inflation, which several academics and policy makers assimilate to price level stability when the measured inflation rate is around but below 2 per cent (owing to a number of measurement biases, as reviewed by Rossi (2001: 31–41)). As a matter of fact, targeting inflation has become a fashion. Since the Reserve Bank of New Zealand first adopted this monetary policy strategy in 1990, an increasing number of monetary authorities around the world – first in advanced economies only, later also in developing and emerging market economies – have been abandoning their monetary or exchange rate targeting strategy to follow this new fashion. As with several fashions nevertheless, targeting an inflation rate rather than an exchange rate or a growth rate of a monetary aggregate has been adopted without any fully thought-out analytical investigation of a phenomenon as complex and controversial as inflation. The same may be argued with respect to previous monetary policy strategies, as they all stem from a symptom-based perception of inflation.

  It is indeed both undisputed and undisputable today that ‘[e]conomists’ perceptions of inflation rest on measurements of the “general price level” and on rates of change of price indexes’ (Gale 1981: 2). In fact, as surveys of inflation theories show, neither a satisfactory nor an exact analytical definition of inflation exists as yet in the literature (see Bronfenbrenner and Holzman 1963, Laidler and Parkin 1975, Frisch 1983, Parkin 1987, McCallum 1990). This is so much so that, to date, the phenomenon of inflation has been grasped merely by considering its most evident symptom, namely the increase of the relevant consumer price index (or some core inflation index), with no analytical thought whatsoever as to its underlying cause.

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  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)

  I n short, other than the Maastricht commitments, the motivation for target adoption was analogous i n nearly all respects to that i n New Zealand, Canada, the U n i t e d K i n g d o m , and Sweden. The Operational Framework of Spain's Inflation Targeting The November 1994 announcement o f the inflation target specified that the medium-term objective o f monetary policy was "a gradual and stable reduction i n the inflation rate, measured i n terms o f consumer prices, to less than 3% over the course o f the next three years" (Banco de E s p a ñ a , 1995b, January, p. 12). The measure o f inflation chosen was the 12-month percentage change i n the all-items CPI, which includes volatile compo- nents, interest-rate effects, tax effects, and the like. I n practice this means that, as i n Israel, the Bank has chosen a simple target definition w i t h the likelihood that complicated explanations o f deviations f r o m the target w i l l be needed. I n introducing the target, however, the Bank observed that factors out o f its control, such as fiscal policy and aggressive wage- setting, m i g h t affect inflation outcomes. 2 1 By 1997, the announcement that inflation was to be below 3% had come to mean that 3% was to be treated as a strict ceiling for i n f l a t i o n — a requirement that, i f taken literally, w o u l d leave little scope for policy flexibility or control error. The "hard" upper l i m i t creates a difficult di- lemma for the Bank: I f the policy-makers try to avoid overshootings by targeting inflation at a level below the ceiling, they are being less than honest with the public about their intentions. But i f they try to meet the target, they are likely to overshoot the ceiling w i t h some frequency. The Bank d i d not confront these issues immediately. Citing the V A T increase effective January 1, 1995, the Bank chose not to set any target for 1995 (a tactic that was employed by Canada and Sweden i n their transitions to inflation targeting).

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  The Inflation-Targeting Debate

  • Ben S. Bernanke, Michael Woodford, Ben S. Bernanke, Michael Woodford(Authors)
  • 2007(Publication Date)
  • University of Chicago Press

    (Publisher)

  Fortunately, this view was accepted outside the Bank, and the governor, Don Brash, whose performance was excellent, retained his job. Attempting to hit the annual target did, however, have the Inflation Targeting in Transition Economies: Experience and Prospects 387 30. As demonstrated by Svensson (1997), a faster target path of inflation to the long-run in-flation goal implies a smaller weight on output variability in the central bank’s loss function. unfortunate consequence of producing excessive swings in the monetary policy instruments, especially the exchange rate. In a small, open economy, like New Zealand, exchange rate movements have a faster impact on infla-tion than interest rates. Thus, trying to achieve annual inflation targets re-quired heavier reliance on manipulating exchange rates, which led to its having large swings. By trying to hit the short-horizon target, the Reserve Bank also may have induced greater output fluctuations. For example, the Reserve Bank pursued overly tight monetary policy at the end of 1996 with the overnight cash rate going to 10 percent because of fears that inflation would rise above the target range in 1997, and this led to an undesirable de-cline in output. The Reserve Bank has recognized the problems it had with a too-short target horizon and now emphasizes a horizon of six to eight quarters in their discussions of monetary policy (Sherwin 1999; Drew and Orr 1999). Furthermore, the Policy Target Agreement between the central bank and the government has recently been amended to be more flexible in order to support the longer policy horizon (Reserve Bank of New Zealand 2000). The solution to avoiding too short a horizon for the inflation target is to set inflation targets for periods two years ahead (or longer). This automat-ically implies that the central bank will have multiyear inflation targets.

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  Issues in Finance and Monetary Policy

  • J. McCombie, C. Rodríguez González, J. McCombie, C. Rodríguez González, Kenneth A. Loparo, Carlos Rodríguez González(Authors)
  • 2007(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  28 3 Inflation Targeting: Assessing the Evidence Alvaro Angeriz and Philip Arestis Introduction Inflation targeting (IT) as a policy framework, designed to tame inflation, has been with us since the early 1990s. Recent work makes the point that a significant number of countries adopted this strategy, and the number is growing. For example, Sterne (2002) suggests that 54 coun- tries pursued one form or another of IT by 1998, compared with only six in 1990. A more recent study (IMF, 2005) suggests that 21 countries (8 developed and 13 emerging) are now clear inflation targeters, pursu- ing a fully-fledged IT strategy (FFIT). Indeed, a number of other coun- tries are seriously considering the adoption of this strategy. Many studies have attempted to examine empirically the degree and extent of the impact of IT on inflation in various countries. We review this litera- ture in what follows and conclude that the available empirical evidence produces mixed results. In pursuing an IT strategy, countries commit themselves to price stabil- ity as the main objective of monetary policy, along with stipulating that medium- to long-term inflation is the nominal anchor where an inflation target is set. There are, of course, varying degrees of commitment to IT amongst countries. In more general terms, one may distinguish between three types of inflation targeting: the FFIT, as suggested above, the ‘Inflation Targeting Lite’ (ITL) type, and the ‘Eclectic Inflation Targeting’ (EIT) type. 1 The main distinguishing feature is the degree of clarity and institutional commitment to price stability. 2 Along with this commitment, an explicit inflation target (either point- or range-inflation target) is set; absence of other nominal anchors, policy instrument independence and absence of fiscal dominance, transparency, accountability and credibility of the com- mitment to IT by the central bank are further requirements (Mishkin

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  Canadian Policy Debates and Case Studies in Honour of David Laidler

  • Robert Leeson(Author)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  171 7 The Political Economy of Inflation Targets: New Zealand and the UK C. A. E. Goodhart 7.1 The Reserve Bank of New Zealand Act, 1989 One of the several occasions on which my path, as a monetary econo- mist, crossed that of David Laidler relates to the adoption in New Zealand of an inflation target, which was effectively introduced in 1988 and then confirmed by the Act of 1989. There is now a detailed record of the events surrounding the passage of this Act, in Singleton, Grimes, Hawke and Holmes, ‘The Reserve Bank of New Zealand Act, 1989’, (2006), and a somewhat more wide-ranging paper by the same authors, ‘Twenty years of modernisation: The Reserve Bank of New Zealand’ (2005). In this latter paper, the authors note that ‘key reforms have often been tested on leading thinkers internationally before implementation. (For instance, aspects of the reforms contained in the 1989 Reserve Bank Act were run past each of Charles Goodhart, David Laidler and Alan [sic] Meltzer)’. In the rather more detailed account of the passage of the Act (2006, forthcoming), the authors note, (fn. 54) that [c]ommentary was also sought from Professor David Laidler (a highly respected ‘monetarist’, then at University of Western Ontario), who was unavailable. However the Bank had discussed relevant issues with Professor Laidler the previous year. The Bank’s file notes record Professor Laidler acknowledging that with the existing state of knowledge and changing relationships between money, GDP and prices, binding monetary policy rules were not feasible; the only alternative was discretionary monetary policy combined with close public monitoring. The Bank’s proposed approach was consistent with this view. The Bank later discussed the issues with another 172 The Political Economy of Inflation Targets prominent visiting monetary economist, Professor Allan Meltzer (Carnegie-Mellon University).

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  Inflation Targeting in the World Economy

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

    (Publisher)

  Only 16 central banks indicate that they routinely ap-pear before their parliaments, but the number is probably higher. Six cen-tral banks produce formal letters when they miss targets. In those cases, as discussed earlier, the letters contain proposals or recommendations about the time frame for returning to the target. Only seven of the central banks publish minutes of their meetings. Thus, transparency and accountability are very much a part of most inflation-targeting frameworks, but there is no uniform pattern. More-over, as with the other three elements normally associated with inflation-targeting frameworks, most of these evaluation devices may be at least as relevant to, and present in, other frameworks for the conduct of monetary policy. Consider, for example, a central bank that uses a monetary or an exchange rate target as its framework for the conduct of monetary policy. If the central bank misses its target, the miss is certainly transparent. Moreover, the central banker certainly can be held accountable for his or her miss! In summary, countries considering the adoption of inflation targeting as the framework for their monetary policy have found the four principal elements useful, at a minimum, to organize their thinking about the de-sign of their frameworks, but there is no one dominant pattern. Actual and Potential Inflation Targeters Before examining in the next section some empirical aspects of inflation targeting and economic performance, it is useful to lay out additional in-formation on the 22 inflation-targeting countries and their inflation and growth experiences in recent years in comparison with those of 46 other countries that might be considered potential inflation targeters.

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  The Monetary Transmission Process

  Recent Developments and Lessons for Europe

  • D. Bundesbank(Author)
  • 2001(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  For this reason, he resorts to a pragmatic solution to my liking: for the time being, achieving and maintaining low in¯ation is a suf®ciently ambitious objective for price stability. This is, moreover, the solution chosen by the Eurosystem and other central banks. The discussion of the issues concerning the maintenance of price stability is, in my view, the core of the chapter and where the most substantive points are 107 108 Jos Äals e Vin raised, both from a theoretical and a practical perspective. Svensson compares the relative merits of three strategies for monetary policy: commitment to a simple instrument rule (e.g. a Taylor rule or a money base rule), forecast targeting (e.g. in¯ation-forecast targeting) and intermediate targeting (e.g. monetary targeting). Before going any further, I would like to say that if the author had written his paper ten years ago, he would have had an even more dif®cult task than at present in trying to ®nd out which is the best way of conducting monetary policy ± that is, which is the best monetary policy practice. The reason why this task is made somewhat easier nowadays ± without having at all become trivial ± is that in recent years a broad consensus has emerged both among economists and central bankers about what should be the most appropriate institutional framework for monetary policy. Consequently, whatever the strategy chosen, monetary policy decisions are nowadays taken within an institutional framework where the maintenance of price stability is the main, the primary or, at least, an important goal of monetary policy, and where central banks enjoy a considerable degree of independence in the pursuit of such goal.

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