Inflation Targeting Essay

In 1981, the inflation rate was the highest, it was about 12.50%. After that, the inflation rate was decreasing and later on its ups and downs. The inflation rate was the lowest in

Another area the RBA seeks to play a role in is controlling inflation levels, targeting limiting consumer price inflation to 2-3 percent.

The Retail Prices Index Excluding Mortgage Payments (RPIX) was to be the new goal and the inflation target was set at 2.5% with 1% tolerance range in 1997. That measurement, changed to the Harmonized Inflation Consumer Index (HICP) with target at 2% with 1% tolerance range in 2003 (Brown, 2003). Chart 1 shows that the inflation rates predicted by the HM Treasury during 1997-2002 and 2003-2006 averaged around 2.5621% and 1.9825%, falling within the tolerance range of the inflation targets with less volatility. In addition,

As we can see from the graph above UK’s inflation in 1980 was 18% followed by a steep drop in 1981 of 11.90%, 8.60% in1982 and lastly 4.60% in 1983 resulting in a highly disinflated economy due to inflation rates sky rocketing which however was dealt severely by the government by decreasing budget deficit and charging higher taxes by cutting extensively on spending.

The Policy Target Agreement (PTA) is an agreement between the Governor of the Reserve Bank and the Minister of Finance. “The Reserve Bank is required to conduct monetary policy with a goal of maintaining a stable general price level.” The economic objectives that the government uphold is encourage and open and competitive economy with the important factors of delivering constant high incomes and standards of living for New Zealanders. “Price stability plays an important part in supporting this objective.” The Bank has to track prices as well as asset prices. The bank has a inflation target of 1 to 3 per cent, they have to focus on keeping future inflation rate within the target of 2 percent midpoint.

On the contrary employment, fluctuations in output and short term goals are all built in the inflation targeting goal. Also targeting policy is a very flexible approach to monetary since every source of information is used to create an appropriate objective to achieve the inflation target. If price stability is achieved then other monetary goals such as maximum employment can be achieved. The risk of letting inflation to get out of hand would cause the average level of prices to change daily, which alters the information being conveyed by the prices of goods and services. As a result economic decision making will be complicated for consumer, business, and the government which would throw the economic system into a chaos. If the economy is in chaos then there will not be an opportunity for any form of growth. In many cases were sever inflation occurs it is followed by political turmoil which can devastate a newly formed democratic nation. Germany experienced this disaster firsthand during their economic and political turmoil in the years of 1920s to 1935. This is described in The Deutsche Bank by David A. Moss, “The economic environment was so chaotic that planning for the future proved almost impossible.”(Moss, P.243).

The majority of central banks have struggled to achieve, let alone sustain, their inflation targets. Despite significant differences with their historic experiences with rising prices, the Fed, the Bank of England, the European Central Bank (ECB) and the Bank of Japan (BoJ) have all set their inflation targets at 2%. Their subsequent failure to achieve this goal has resulted in accommodative policy being left intact or, in some cases, even intensified, resulting in some instances to internal dissent, most notably on the Federal Open Market Committee (FOMC). All of the aforementioned central banks will understand the critical role of expectations in determining the inflationary backdrop. Given the differing experiences of inflation in the US, UK, Eurozone and Japan, there is no reason whatsoever why these countries should have analogous levels of inflationary expectations held by the private sector and, therefore, why their central banks should adopt the same inflation target. Both the ECB and BoJ have considerably undershot their respective inflation goals and they have responded with ever more aggressive quantitative easing. Meanwhile, the BoJ has, once again, been forced to trim its inflation forecasts in another apparent blow to its credibility. The BoJ now believes the 2% target will not be achieved until March 2018. If the forecast is correct, then their objective will have been reached three years later

Thus by altering the supply of money in the economy, spending and inflation could be controlled. Friedman’s fixed money rule proposed that in order to target a specific rate of inflation, central banks should gauge the money supply based on its relationship to macroeconomic variables. He suggested the idea of “setting the rate of monetary growth with the nominal interest rate at zero and merely reducing inflation rate π*, so that(1+r)(1+π^* )=1. (Smith p.296). Taylor rule on the other hand, basically stated that the CB should just alter the short-term interest rate in response to perceived deviations of inflation and output from their targets. In order to stabilize the economy in the short run and achieve its long-run goal for inflation. Thus the monetary policy rule proposed by Taylor is:

From its inception, the central bank’s onus has always been a dual mandate; to maintain maximum employment while at the same time keeping stable prices. While we as economists have learned much about the mechanism through which monetary policy affects the economy, much is still unknown about the inner workings of the economy, and the long-term effects of varying monetary policy. Over the past two decades, the Federal Reserve has dictated that the inflation target rate should be close to two percent for the American economy, yet this idea has come into question in the past 5 years.

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,

Dramatically expansive monetary policy- Goal is to end deflation, lead to an increase in prices to an order of 2% of CPI (around 1% of GDP inflator).

On the other hand, the ZLB is a global phenomenon, “The main policy rate of the central bank is currently at zero (or close to zero) in 22 out of 34 OECD countries” displays the worldwide struggle of central banks since the global financial crisis (Wiederholt, 2015, 1). At the ZLB central banks must look at unconventional policies, however Japan shows us it remains extremely difficult to stimulate growth and inflation. In 1999 the BOJ introduce Zero Interest Rate policy (ZIRP) when it lowered in the interest rate to virtually zero. The BOJ also incorporated future policy statements indicating the rate would remain lower for longer this “is to lower future expected interest rates and thereby boost spending immediately” and cause reflation (Williams, 2014, 6). However, expected inflation will only increase if the bank credibly commits to its policy and it is merely not transitional. The BOJ stated ZIRP would remain until “until deflationary concerns disappeared” which is too vague and does not give private agents enough information, therefore casting doubt on competence of the BOJ (www.boj.or.jp, 1999). Setting an inflation target would help quantify the BOJ objectives. Krugman (1998) argued for the BOJ to “credibly promise to be irresponsible” and not reverse ZIRP once inflation increases plus set an inflation target higher than desirable. Bernanke (1999) agrees by setting an inflation target of 3-4% would highlight the movement of BOJ away from a deflationary regime.

Between 2002 and 2004, the monetary freedom indictors decreased as a result of a number of factors, including a loss of policy credibility, currency weakness, deteriorating terms of trade and a reduction in fuel price subsidies. In 2004 the annual inflation reached 18.14%, Inflation became the principal threat to economic stability; the government intervened reforming the monetary policy. (see Exhibit 7)

Speaking at a press conference in Lagos recently, the President of NECA, Mr. Larry Ettah, argued that the current monetary policy tools have not been effective in reducing inflation in Nigeria, given that the country’s inflation has mostly been driven by currency devaluation, food

The primary objective of the Reserve Bank of NZ (RBNZ) is to maintain price stability. In recent years, there has been a shift from multiple targets of MP, under political control, to a single target, which is inflation control. During the 1990’s (NZ) shifted to a new policy regime, where inflation was forecasted and a target was set for the forecast. The Government of