Academic journal article The Journal of Social, Political, and Economic Studies

Inflation Targeting Policies in Less-Developed Countries: Some Evidence and Potential

Academic journal article The Journal of Social, Political, and Economic Studies

Inflation Targeting Policies in Less-Developed Countries: Some Evidence and Potential

Article excerpt

Inflation Targeting (IT) is a macro-monetary policy tool, originally introduced in New Zealand and now adopted by several countries, that can lead to relatively stable and low inflation rates through the adoption of an explicit inflation target, one that can, if successful, lead to enhanced credibility, transparency, and accountability. While noting some of the pros and cons, evidence reveals considerable success in various less-developed countries (LDCs) with this approach, though results with respect to DCs are rather mixed. IT success in the LDCs means reduced inflation rates and lower output volatility, and diminished inflationary expectations. The paper examines these aspects of inflation targeting and also discusses Chile's experience with IT and the lessons from that experience that can be potentially useful for other LDCs.

Key Words: Inflation targeting; Monetary policy in developed countries; Monetary policy in less-developed countries; Chilean monetary policy; Causes of inflation.

I. Introduction

There is substantial consensus among economists and policy-makers that low and stable inflation is one key component of achieving economic stability. Inflation Targeting (IT) is a recent approach toward achieving this goal. The IT macro-policy instrument was first developed in 1988 by the New Zealand Central Bank. Since that time, IT has become increasingly popular. Approximately 23 countries that fall into the categories of developed (DCs), less-developed (LDCs), and transitional economies have implemented IT, and more are on the way. IT is a macromonetary policy instrument whereby a country implements an explicit inflation target, the primary focus of the central bank is achieving a low and stable inflation rate (Woodford, 2). In addition, an IT framework allows the central bank to gain more control over inflation by anchoring inflationary expectations of the private sector (Bernanke, 2003,2; Faust, et. al., 122-123).

The public's inflationary expectations are anchored by evidence of transparency, credibility, and accountability on the part of a nation's central bank. Transparency is defined as "the ability to monitor the central bank's performance" (Walsh, 1). Thus, transparency is designed to minimize the disproportionate amount of information that the central bank holds in comparison to the public (Jarmuzek, et. al., 7). The Code of Good Practices on Transparency in Monetary and Financial Policies, adopted by the International Monetary Fund (IMF) in 1999, states that a transparent monetary policy clarifies the central bank's roles, tasks, and goals to the public, typically disseminated through periodic publications. The significance of transparency in an IT framework is that the public no longer needs to speculate about inflation, thus enabling the central bank more control over inflationary expectations.

In order for a transparent policy to contain inflationary expectations, the central bank must have credibility with the public. Credibility refers to the public's belief that the central bank will remain committed to achieving its inflation target and goals (Carare-Stone, 12). However, consistently achieving the inflation target is highly unlikely. When the target is missed, action needs to be taken to minimize the loss of policy-makers' credibility with the public. Accountability is defined as the central bank being held responsible for its actions when the inflation target is missed (Cecchetti, 23). If the central bank fails to meet its target, some form of discipline must be applied until the target is achieved, or an explanation is provided why the target was not achieved. Generally, it would tend to diminish the central bank's discretionary-policy flexibility but it enhances its transparency. The discipline, similar to a penalty, is applied until the target is met or the failure to meet the target is justified. An example of this type of discipline is incorporated in the Reserve Bank of New Zealand Act of 1989. …

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