Inflation Targeting

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Inflation targeting
Lecture 11

Objectives
to explain the concept of inflation targeting;

to see how is implemented inflation targeting;

to identify the role of credibility and transparency on the monetary policy efficiency.

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Inflation targeting

Brief history
Canada – 1991 UK –1992 Finland – 1993 Sweden – 1993 Spain – 1994 Australia – 1994 Chile – 1991 Israel – 1992 Peru – 1994 Poland – 1998 Czech Rep. – 1998 Romania - 2005

New Zeeland - 1990
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Inflation targeting

What is inflation targeting?
“… a framework for monetary policy characterized by the public announcement of official quantitative targets (or target ranges) for the inflation rate over one or more time horizons, and by explicit acknowledgement that low, stable inflation is monetary policy’s primary long-run goal” Bernanke, S.; Laubach, T.; Mishkin, F.S.; Posen, A. (2001)

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Inflation targeting

What is inflation targeting?
Essential issues of inflation targeting
price stability – the sole objective, or at least the main objective official quantitative target for inflation objectives and instruments’ independence communication strategy with the society maintaining and increasing the level of credibility

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Inflation targeting

A framework, not a rule
Rules  Discretion (freedom of action)
Woodford: “ central banking is not like steering an oil tanker, or even guiding a spacecraft, which follows a trajectory that depends on constantly changing factors , but does not depend on the vehicle’s own expectations where it is heading”, while the society, based on its own expectations and on the credibility of central bank, will react, modifying its expectations and its behavior.

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Inflation targeting

A framework, not a rule
constrained discretion
impose a conceptual structure and its inherent discipline on the central bank does not impose rules, but ask for a detailed analysis of economic environment. transparency and credibility are essential

but without eliminating all flexibility
it is allowed to follow other objectives in the short run, without the prejudice of price stability

cautious approach to monetary policy
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Inflation targeting

Issues of design and implementation
choosing the appropriate measure for inflation
CPI core inflation

the numerical value of the target
price stability: NOT 0% inflation
CPI does not reflect the substitution process and the increase in the quality of goods and services Phillips curve and natural unemployment rate hampers the mechanism of monetary policy – too low interest rates deflation

Price stability: 1 - 3%
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http://bnr.ro/Inflation-Targets-3241.aspx

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Inflation targeting

Issues of design and implementation
horizon for the target
1 – 4 years projection communication

the choice between targeting a point or a range
the width of target range missing a point or a target range

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Inflation targeting

Issues of design and implementation
deviations from the target
changing the target escape clauses

central bank accountability
A central bank should be independent of all political pressure or should be directly accountable to the public? instruments and objectives independence

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Inflation targeting

Issues of design and implementation
communication issues
information to be communicated:
inflation targets information about the current outlook of the economy reports, studies, forecasts regarding the inflation explanations regarding the failures in achieving the targets explanations regarding the forecasts

ways to communicate
Speeches, press conferences Inflation report

Frequency readiness and the degree of details
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Inflation targeting

Issues of design and implementation
the best moment to adopt inflation targeting
When inflation is low or high? Recent achievements in...
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