Inflation Targeting_ A new framework for Monetary Policy_

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					   Inflation Targeting: A new
framework for Monetary Policy?

  By Ben Bernanke and Frederic Mishkin

   Presented by: Andrew Hicks and Mike
    Key discussions in this article
• Strategy for Monetary Policy known as
  “Inflation targeting”
• How inflation targeting has been implanted in
• Argument that it is a framework for policy
  rather than an ironclad policy rule.
• Additional practical issues raised by inflation
                Key Findings
• When viewed as a framework and not a rule
  the advantages are
  – More transparent and coherent policy making
  – Increased accountability
  – Greater attention to long run consideration in day
    to day policy debates and decisions.
• What is Inflation targeting / what countries
• Discuss the differences between policy
  framework and a policy rule
• How can Inflation-targeting accommodate for
  short run issues
• How inflation framework improves
• Analyze some questions that surround the
  inflation-targeting approach
• Conclusion
      What is inflation targeting
• An announcement of official target ranges for
  the inflation rate at one or more horizons
• Explicit acknowledgment that low and stable
  inflation is the overriding goal of monetary
• Some other features of inflation targeting
  include increased communication with the
  public and increased accountability of central
  bank to attain their objective.
    Countries that Use Inflation Targeting
•   Canada
•   United Kingdom
•   Israel
•   Spain
•   Finland
•   New Zealand
•   Sweden
•   Australia
       A Framework, Not a Rule
• A rigid policy rule would:
  – Ignore the fact that central banks are concerned
    with variables besides inflation
     • Such as; exchange rates, employment, output, etc.
  – Which in turn would lose traction with
     • The public
     • Central bankers
     • Many monetary economists
       A Framework, Not a Rule
• A rule provides “simple mechanical
• But, Inflation-targeting encourages central
  banks to use all information as well as their
  structural and judgmental economic models
• By using a framework approach, it allows
  central banks discretion
• Eg. Have response to short-run developments
     Short Run Accommodations
• Generally Inflation targeting is a long run
• Many central banks use short run stabilization
• Usually dealing with output and exchange
• Accomplished through various means
   Short Run Stabilization means
• Eliminate or reduce the effects of “supply
• Central banks target a price index that may
  exclude combinations of energy and food
  prices, indirect tax changes, imputed rental
• Which lowers fluctuations to the specific index
   Short Run Stabilization means
• Specify a range instead of a certain percent

• Gives the central bank some leeway in the
  short run

• Describes some uncertainty between policy
  tools and outcomes
   Short Run Stabilization means
• Allow for adjustment to shocks

• Eg. Deutsche Bundesbank declared an
  “unavoidable” inflation rate in response to the
  1979 oil shock
• Central banks can incorporate an “escape
  clause” to deviate from previously specified
  ranges in the case of adverse events
      Improved Communication
• Countries that use inflation-targeting must
  give the public timely information about
  policies and current and future states of
• Eg. Bank of England releases a quarterly,
  Inflation Report , Sweden, Canada and New
  Zealand also have similar document releases
      Improved Communication
• Inflation target announcements;
  – Allow for private sector planning
  – Reduces uncertainty over inflation in the future
  – Makes the central banks intentions clear to the
    public and markets
  – Central bank becomes more accountable
Questions about Inflation-targeting
• Which Inflation Measure?
  – The price series that a central bank chooses must
    be; readily understood by the public, timely and
  – Account for price shocks, or any shift that do not
    effect “trend inflation”
Questions about Inflation-targeting
• What is the best target value?
   – Zero inflation is not desirable
      • Even if a central bank announces a zero rate, the public and
        private sector will not believe them
   – Setting the target too low
      • Reduces real-wage flexibility which can effect the labor markets
        efficiency (using the theory that nominal wages are rigid, then real
        wage reductions can only happen through inflation of price level)
      • When the target is set too low the economy has an easier chance
        for deflation
   – A target value that provides the inflation rate with a ceiling
     as well as a floor, can accommodate positive and negative
     shocks to demand
Questions about Inflation-targeting
• Is Inflation predictable and controllable enough
  to be “targeted”?
  – Lags between monetary policy and the reaction of
    inflation infers that it may be difficult to choose a
  – Central bank credibility can be challenged if inflation
    is unpredictable and they are not forecasting correctly
  – Although in the United States, inflation has been
    relatively stable from the 1980’s onward, which one
    may indicate easier predictability in the future
Questions about Inflation-targeting
• Is inflation the right goal variable for
  monetary policy?
   – Some economists believe that Nominal GDP
     growth rate should be the target
      • Has focus on both prices as well as output
   – Why they prefer Inflation?
      • Information for prices is quicker and more frequently
      • Inflation is a more accepted and understood concept to
        the public than nominal GDP
• Advantages of Inflation-targeting framework
     • Transparent policy-making
     • Central bank becomes more accountable
     • Increased long-run considerations in the day-today
       policy decisions
  – Although
     • Bernanke and Mishkin admit that they were unsure if
       inflation-targeting will become a “fad or a trend”
       because of its infancy

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