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The Best Economic Environment For Inflation Targeting

1334 words - 5 pages

In the past two decades, a multitude of countries, including Canada and Australia have instituted “explicit inflation targeting” (Svensson, 1996, p.1) for fear of the high cost of “volatile inflation” (Freedman&Laxton, 2009, p. 6).Mishkin offered the definition of inflation targeting (IT). It is a monetary policy strategy intended to achieve price stability within a specific range (Mishkin,2000).As is concisely demonstrated by Mishkin, IT “establishes a transparent and credible commitment” to the precision of the future “numerical objective”(Mishkin,2008).Nonetheless, it is not a prudential policy. It is prone to encounter the predicament of “long and variable lags” of “implementing and monitoring” the policy (Svensson, 1996, p.2). Under current circumstances, IT is facing the pressure of the economic crisis. It goes a step further to aggravate the intricacy of the conduct of IT (Mishkin, 2008).

Two distinctive categories of countries have been incorporated in this paper, industrialized countries and emerging-market countries. With the aim of illustrating the best economic environment for IT, I will resort to methods of analysis, definition, exemplification, comparison &contrast, etc. In this paper, I will argue that inflation targeting operates best in the economic environment where independent central banking(CB), strong fiscal position, sound financial system and flexible exchange rate are integrated.

Frederic Mishkin(2000) stated precisely what IT is in his paper, “Inflation targeting is a monetary-policy strategy that encompasses five main components”:(i) the public announcement of medium-term numerical objectives for inflation;(ii)an institutional commitment to price stability as the primary goal of monetary policy; (iii)an informative approach in which many variables and not just monetary aggregates or the exchange rate, are used for deciding the setting of policy instruments;(iv)strengthened transparency of the monetary-policy strategy through communication with the public; and(v) intensified accountability of the central bank for attaining its inflation objectives(Mishkin,2000,p.105).

IT embraces a variety of merits as an intermediate monetary strategy (Mishkin, 2000).It concentrates on the domestic economy and weakens the relationship between money and inflation. Thereby, monetary authorities are capable of constructing the setting of monetary policy with all information available (Mishkin, 2000).In the public sense, it is understandable and thus improves the transparency of the performance of the policy. The highlight of inflation targeting regime is that CB is highly accountable for the process and effect of the policy. Svensson expressed approval of “the commitment mechanism” CB forms to correlate the “ex post measurement” and the inflation target (Svensson, 1996, p.1).Additionally, IT serves as a channel of communication, enabling the public to be fully informed of the potential trend of inflation and...

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