Inflation Targeting essay

Inflation is usually considered to be a bad phenomenon. Together with unstable prices for goods and services, it spoils economies and investments, provokes capital flight, restrains the development, prevent real economic planning. Moreover in its intense form, it provokes political and social turbulence. Governments accordingly consider inflation to be a pestilence and do its best to stop it by creating preservative and well-founded economic and financial policies. Practice and expediency made the government to carry out its financial policy by counting on intermediary targets. These are exchange rates and financial aggregates.

But last time it became clear that this is not a right decision after some highly developed economies fell into decay and then started to pay attention to the inflation rate. This new way to solve the old problem or supervise the level of inflation is called inflation targeting. The main reasons for inflation targeting It is essential to review why these states apply inflation targeting instead of alternative monetary policy frameworks. The main reason is that the government of these states considers the price constancy that means a not very high and stable inflation rate to be the main achievement that financial policy can make.

Secondly, the practice has shown that temporary operation of monetary policy to reach other aims, such as higher employment or maybe improved better production, can come into collision with price steadiness. Many experts thank that an effort to reach several economic purposes gives financial policy an inflationary incline. (Pyyhtia 1999) Central banks surely received more community disapproval for rates increasing (a usual anti-inflationary course) than for making they lower.

Consequently banks are usually forced to improve financial stability. Inflation targeting usually helps restore this irregularity. It realizes that by making inflation, -not the production, employment or something else -the main objective of financial policy. Moreover it makes the bank to plan carefully, in order to have the possibility to tense strategy and not to let the level of inflation become too high. “U. S. Inflation Targeting: Pro and Con,” FRB San Francisco Economic Letter, May 29, 1998. Inflation targeting is simple.

The central bank predicts the prospect course of inflation; the prediction is paralleled with the objective inflation rate (the one that is the most proper for the economy); the dissimilarity between the prediction and the objective defines how much financial strategy must be improved. States that apply inflation targeting think that it should plan the financial policy to be implemented by central banks. (Pyyhtia 1999) This paper examines three problems connected with in inflation targeting. It clarifies the needs for bringing such strategy to life.

Then, it evaluates the practice of the seven developed states which already applied it. And at last, it considers if inflation targeting is applicable for the states with developing economy. (Pyyhtia 1999) Inflation targeting needs two important factors. The first thing is a central bank implementing financial policy independently. Of course a bank can’t be fully independent and not influenced by the government; however it should create the ways to reach the proper rate of inflation set by the government itself. In order to meet these requirements, a state cannot show indication of “fiscal supremacy”.

Independence from fiscal supremacy means that government loans in the central bank is not very high or does not present at all, and that monetary markets have sufficient deepness to take up placements of community debt. It also means that the administration has a large income base and may not rely steadily and considerably on income that come from the monopoly. If economic supremacy is present, inflationary pressures of a financial source will weaken the efficiency of financial strategy by making the central bank meet the requests of the government, by lowing interest rates in order to reach financial purposes.

“U. S. Inflation Targeting: Pro and Con,” FRB San Francisco Economic Letter, May 29, 1998. The next condition for inflation targeting to function is the readiness and capability of the financial policy not target at other showing (salary, the level of joblessness, etc. A state that select a set exchange rate scheme, for instance–that is helpful in definite conditions–subordinates its financial strategy to the exchange rate target and will not be able to manage an inflation-targeting scheme, particularly if resources can shift easily in and out of the state.

As the community cannot be completely sure that the authorities can the put inflation objective priority over the exchange rate objective or contrariwise, policy will not like the credibility necessary for achievement. (Roger 1998) A state that can satisfy these two basic conditions will be able theoretically to carry out a financial policy through inflation targeting. Actually, the government may also need to make definite preliminary preparation. First it is necessary to set up clear quantitative targets.

Secondly, it is essential to specify clearly and unmistakably to the community that reaching the inflation target is the primary goal of financial policy. Third, they must create a pattern or tactic for inflation forecasting that applies a quantity of showing containing data on future inflation. Lastly, it is necessary to invent a highly developed operating process in which financial policy tolls are adjusted (together with the evaluation of future inflation) to achieve the necessary goal.

The financial authorities should have the methodological and institutional ability to manage and predict domestic inflation, define the time period between the correction of the monetary tools and their influence on the inflation rate, and know about the of the comparative efficiency of the different tools of financial policy. ( Roberts 1995) Inflation targeting characteristics It is essential to discuss the advantages of inflation targeting in comparison with other methods of stopping inflation. The main advantage is that the policy is focused on relies regular evaluation of future inflation.

Inflation targeting implies that financial authorities openly identify the inflation objective and set up exact institutional preparations to achieve this goal. ( Roberts 1995) Identifying the inflation target includes choosing a price index to specify the target, establishing the objective “in terms of either the price level or the rate of inflation, giving the target a numerical value, deciding whether to define the target as a point or a band, and determining possible escape clauses or exemptions to the inflation target under specific circumstances.

Setting the institutional arrangements implies determining if whether to make conformity with the inflation objective an official target or just a set necessity of financial policy, defining the proper ways to include inflation targeting into the general macroeconomic strategy, and work out measures to guarantee its clearness and liability. (Rotemberg 1999)