Has Inflation Targeting Reduced The Efficacy Of Monetary Policy? Essay

Levin, A. T., Johannsen, B. K., & Beechey, M. J. (2011). Are long-run inflation expectations anchored more firmly in the euro area than in the united states?. American Economic Journal: Macroeconomics, 3(2), 104 - 129. doi:

1. What is inflation? Inflation is an increase in prices for goods and services (What is Inflation?).

The discussion of whether the Federal Reserve should raise the federal funds rate is a highly contentious one. Members of the Federal Reserve (“Fed”) and academic economists disagree about what constitutes appropriate future macroeconomic policy for the Unites States. In the past, the Fed had been able to raise rates when the unemployment rate was under 5% and inflation was at a target of 2%. Enigmatically, since the Great Recession and despite a strengthening economy, year-over-year total inflation since 2008 has averaged only 1.4%—as measured by the Personal Consumption Expenditures Price Index (“PCE”). Today, PCE inflation is at 1-1.5% and has continuously undershot the Fed’s inflation target of 2% three years in a row. (Evan 2015) In the six years since the bottom of the Great Recession the U.S. economy has made great strides in lowering the published unemployment rate from about 10% back down to about 5.5%. In light of this data, certain individuals believe that the Federal Reserve should move to increase the federal funds rate in 2015 because unemployment is near 5% and inflation should bounce back on its own (Derby 2015). However, this recommendation is misguided.

To begin, The Federal Reserve System opted to raise interest rates that were placed near zero years ago in order to aid the economy’s growth and prevent inflation from exceeding the target number. Several factors including: the five percent drop in the unemployment rate, and the increase in wages, and the outlook on future inflation contributed to the Federal Reserve’s decision take this action. However, the increase in interest rates in December has generated mixed results, and it appeared the Federal Reserve would announce the interest rates were going to increase again. Instead, Janet Yellen, the chairman of the Federal Reserve, announced that there were better days ahead for the economy, and a slow and careful approach to future increases in the interest rate would serve the economy best, ensuring the growth is maintained. Although the interest rates remained the same early in 2016, they are expected to increase during the June meeting of the Federal Reserve. but cited the economy needed low interest rates in order for the economy to maintain growth. I find it interesting that Yellen continues to worry about inflation growing in the coming years, although the interest rate increase should keep inflation in check through its effect of the economic markets. Yellen sites that she would like the inflation to become and stay at 2 percent each year. However, the current inflation rate is .9 percent, so the the economy is a long way from achieving its target inflation rate

Mr. Emanuel, in the current economic climate, the Obama administration’s course of action has been to pursue aggressive countercyclical fiscal policies designed to prevent further economic deterioration. Critics of these policies argue that:

It widely recognized that the monetary policy within a country should be primarily concerned with the pursuit of price stability. However, it is still not clear how this objective can be achieved most effectively. This debate remains unsettled, but an increasing number of countries have adopted inflation targeting as their monetary policy framework. (Dr E J van der Merwe, 2002) This topic of Inflation targeting is a subject which immediately conjures different perceptions from different people. Many feel that low inflation should be a main aim of monetary policy, while others (such as trade union activists) believe that a higher growth rate to stimulate jobs should be the main concern.

Unfortunately, the increased importance of policy language has increased the scope for misinterpretation, as well as ambiguity. A hawkish view of future Fed policy can be taken from the decision to abolish the Evans Rule, named after the President of the Chicago Fed. This formed the bedrock of the policy thresholds. The Evans Rule was designed to tell markets that policy rate settings would not change until certain economic conditions were satisfied. Consistent with its dual mandate, the FOMC announced policy thresholds covering both unemployment and inflation. The unemployment threshold (6.5%) always dominated the inflation equivalent (2.5%), even though the Fed never had an explicit long-term target rate for unemployment. In contrast, the Fed has a long-term inflation target of 2%. Under the Evans Rule, given that the threshold was above the target, there was scope for inflation to overshoot. The abolition of the Evans Rule and the policy thresholds now means that the 2% inflation target effectively becomes the ceiling. The importance of inflation in setting the policy rate has increased: low interest rates will only prevail if inflation remains below 2%. This potentially marks an important shift in the Fed’s thinking on the trade-off between unemployment and inflation. Previously, Fed Chair Yellen believed the costs of overshooting the inflation target were lower than those associated with elevated unemployment.

One of the most consistent defenses against deflation is for a central bank to target an inflation rate greater than zero. The Federal Reserve’s current inflation target is 2% and has informally been at that rate for quite some time. This nonzero target provides a cushion for policymakers: should inflation decrease due to an unexpected shock to aggregate demand, prices should not immediately start falling. This allows policymakers to act with easy money when inflation reaches 1 or 0%, thus avoiding deflation. Yet, during the last two recessions in the United States, the 2% inflation rate did not prevent significant fear of deflation. Extraordinary action was required, and many economists argue that the low interest rate policy following the 2001-2002 recession contributed to the housing bubble that was inflating at that time. It is not yet known what the impact will be from the unorthodox policies taken in response to deflation fears in 2009-2010. Based on these experiences, it may be time to consider alternative inflation targets to provide greater insulation from deflationary pressures.

Why is inflation bad for the American economy? Imagine going into the popular local food market or gas station several times a week. After a couple of weeks, imagine going into these stores and noticing the prices have steadily increased over the past few months. This is called inflation, and it is causing many problems in the United States. There are three different types of inflation: demand-pull, cost-push, and built-in. Demand-pull inflation occurs when prices increased because of such high demand. Cost-push inflation is when prices surge resulting from high input costs. Built-in inflation is when prices continue to rise after any natural causes. The inflation occurring in America is a demand-pull. Inflation has affected the United

On September 18, 2013 the Federal Reserve reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In addition, the committee agreed to continue its monthly $85 billion purchase of Treasury and mortgage-backed securities as long as the unemployment rate remains above 6.5 percent. Inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal and longer-term inflation expectations continue to be well anchored .

Monetary policy effects the GDP inflation. “Between 1996 and 2000, real GDP in the United States expanded briskly and the price level rose only slowly. The economy experienced neither significant unemployment nor inflation. Some observes felt that the United States had entered a “new ear” in which business cycle was dead. But that wishful thinking came to an end in March 2001, when the economy entered its ninth recession since 1950. Since 1970, real GDP has declined in the United States in five periods: 1973-1975, 1980, 1981-1982, 1990-1991 and

There are different influences that cause inflation such as energy, food, commodities, and other goods and services. The entire economy is affected by rise of the cost of living. It also affects the cost of operating a business, borrowing money, mortgages, corporate and government bond yields, and every other aspect of the economy. There are several advantages of inflation in the economy. Some include moderate rates of inflation which allows prices to adjust. This is considered a sign of a healthy economy. With economic growth available we usually get a generous amount of inflation. Also moderate inflation rate reduces the actual value of debt. If there is a reduction, the real value of debt increase leads to a squeeze on usuable income.

Since the last century 90s, the past innovations in finance have made the money supply be calculated increasingly difficult as well as the relationship between the money supply and the inflation have also become more and more unstable so that the problem that the velocity of monetary is volatile appeared in the economy. That is why a number of central banks have already given up controlling the monetary aggregate so that they can achieve inflation targeting directly or indirectly. According to the Taylor rule, it has been argued (Bernanke and Woodford 1997) that the forecasting of the inflation rate has become quite important for the policy maker and the private sector. Finally, many scholars developed a new instrument in order to control the inflation and it is called the inflation forecast. Furthermore, this new technique is paid more attention especially in a few countries, which are, utilized the inflation targeting. Nowadays, decisions of the central bank begin to rely more and more on the future inflation rather than the past historical information and some central banks even regard the inflation forecast as an intermediate target of the monetary policy. Up to now, the mechanism of the inflation forecast has been adopted in over twenty countries in order to provide evidence for the policy formulation of the central bank. These countries include the developed country such as Australia, United kingdom, Canada and so on as well as the developing country for instance

Discuss the role of government policy in reducing unemployment and inflation. In your discussion make use of the diagrammatic representation of the macroeconomy developed in lectures in Term 2

Inflation forecasting plays a central role in monetary policy formulation. Recent international empirical evidence suggests that with the decline in inflation of recent years, a fairly widespread phenomenon, the combined dynamics of this variable and its potential predictors, such as money or different measures of the output gap, has changed, and inflation has become more unpredictable. Univariate models tend to show a better forecasting capacity than those based on various inflation theories, such as the Phillips curve. Traditionally, in industrialized countries the Phillips curve has played a predominant role in inflation forecasting, and according to Stock and Watson (1999), Atkenson and Ohanian (2001) and Canova, (2002), it would seem to perform better in terms of forecasting error than other alternative models. In recent years there have