Inflation Targeting

The Federal Reserve has the dual job of ensuring price stability and maximum employment, which are contradictory objectives. The Feds try to achieve the goals through monetary policy which determines the demand and supply of money by controlling interest rates. The Fed’s goal is to achieve a natural rate of unemployment of more or less 5%. When the actual unemployment figures are below the natural rate of unemployment, inflation increases and there is a high demand of goods and services propelling the economy with the ensuing labor demands and the pressure it places on wages, which in turn produces inflation. When the Fed is faced with this scenario, it must increase the rates to slow the growth and achieve price stability (contractionary cycle).

Inflation is a general increase in the prices of all goods and services. Inflation occurs when the average level of prices in the economy increases over time. Even as overall prices are increasing, particular relative prices will change. The US Federal Reserve attempts to control and reduce inflation. Central banks focus is on strictly controlling inflation, protecting financial assets, and keeping labor markets strictly in check. Central Banks hold inflation more important than unemployment. Central Banks believe the only long-run impact of monetary policy is on the rate of inflation. They believe free-market forces in the real economy determine real output, employment, and productivity. To attain the targeted inflation rate, central banks influence credit creation and hence spending by frequently adjusting interest rates.

The Federal Reserve should utilize a balanced approach to monetary policy. The current state of the economy—undershot employment and inflation goals—presents no conflict in achieving a neutral state. In fact any action that supports employment growth also moves inflation up toward our target (Evan

This is an example of complicating the policy response. In recent years, a singular emphasis on targeting inflation has come to dominate debates on macroeconomic policy with strong calls to leave monetary and foreign exchange policies to an independent central bank. However, whatever the specific tools employed and regardless of who controls them, fighting inflation usually leads to higher unemployment and the risk of lower investment and growth in the medium term.

The Federal Reserve Act lays out the monetary policy that states that the Board of Governors and the Federal Open Market Committee should look for "to support effectively the aims of maximum employment, stable prices, and moderate long-term interest rates." The pre-requirement for highest sustainable growth and employment rates along with long term interest rates is price stability in the long run. Long run stable prices prevents merchandise, services, materials and labor from getting distorted by inflation and hence turn out to be good indicators to the proficient distribution of resources and consequently add to better and higher standards of living (Meyer, 2004). Moreover, price stability promotes saving and generates capital since the risk of inflation causing attrition of asset values is decreased and hence people are driven to save more and business tend to invest more.

Most people don’t understand Economic growth or what takes place in the economy with regard to inflation, unemployment, or interest rates. These things are all regulated by the central bank called the Federal Reserve System. The tope covered in this paper is the monetary policy which is the policy that decides if unemployment, interest, and inflation decreases or increases. The Monetary policy decides what price a person pays for an item at the store, how much interest a person will get charged on a loan for a car. This is something most people consider, most just look for the best price point or look where their money can go the farthest.

The last five years have shown that traditional monetary policies predicated on interest rate management by the Federal Reserve no longer deliver the economic growth they were once believed to. Keynesian economics has proved to not be as effective as once thought, which has led to the Federal Reserve choose alternative means to stimulate the economy and indirectly manage exchange rates (Hakkio, 1986). The uncertainty over interest rate polices has fortunately not led to increases in inflation, which has typically been the case in the past (Kopcke, 1988). The current economic conditions and the approaches the Federal Research are taking however are cause for concern, and from a personal standpoint many decisions are being evaluated more precisely.

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.

The monetary policy was successful in the inflation targeting(IT) framework, which them main difference to the multiple-goal approach is that IT puts price stability at the first.. The IT practice can helped central bank to get well inflation expectation of their goal of price stability.

3. Which of the following do policy makers tend to target when setting monetary policy?

Monetary policy, ‘The government’s policy relating to the money supply, bank interest rates, and borrowing’ (Collin: 130), is another tool available to the government to control inflation. Figure 4 shows, that by increasing the interest rate (r), from r1 to r2, the supply of money (ms) is reduced from Q1

Inflation is a possible cause of higher unemployment in the medium term if one country experiences a much higher rate of inflation than another, leading to a loss of international competitiveness and a subsequent worsening of their trade performance. If inflation in the UK is persistently above our major trading partners, British exporters may struggle to maintain their share in overseas markets and import penetration into the UK domestic market will grow. Both trends could lead to a worsening balance of payments. The UK government believes that monetary stability (i.e. low inflation) is a precondition for sustained economic expansion.  As the chart below demonstrates, the UK has made progress in reducing the volatility of its inflation rate in the last decade. The era of high and volatile inflation may have come to an end.

Inflation is blazing subject that delays the economic development of the country. It is becoming extra hectic to economists, politicians and even people also. Factors on both demand and supply effect the inflation. So the stabilization strategies ought to consequently focus on both demand manipulation as well as

| Advocates of active monetary and fiscal policy view the economy as inherently unstable and believe that policy can manage aggregate demand, and thereby, production and employment, to offset the inherent instability. When aggregate demand is inadequate to ensure full employment, policymakers should boost government spending, cut taxes, and expand money supply. However, when aggregate demand is excessive, risking higher inflation, policymakers should cut government spending, raise taxes, and reduce the money supply. Such policy actions put

Unemployment and inflation are factors that have negative effects on the performance of the economy as a whole. Therefore, policies to achieve low and stable price inflation, a high and stable level of employment are big macroeconomics issues of our time. This essay focuses on discussing the role of government policy on reducing unemployment and inflation in relation to Keynesian and Monetarist approaches, including examples of impacts of expansionary fiscal and monetary policies on New Zealand economy.