What Is Inflation Targeting?
Inflation Targeting is a monetary policy adopted by the Central banks to manage the level of inflation in the economy. It involves setting a specific target rate for inflation by using policy tools.
New Zealand, Canada and the UK were the first three countries to introduce full-fledged Inflation Targeting in 1990.
In other words Inflation Targeting is a common practice among Central banks World wide. It aims to influence the price levels in an economy by using several monetary policy tools.
Creation Of the Inflation Targeting Framework
The Inflation Targeting Framework was firstly developed by the Reserve Bank of New Zealand in 1988-89. It gave the target of an inflation rate of 0-2 % range and the operational independence to pursue it. Then Inflation Targeting was adopted by Canada & Chile in 1990 & In 1991 by UK & Israel.
Examples Of Countries that have adopted Inflation Targeting
Several Countries have adopted Inflation Targeting as per their Central bank’s monetary policy framework. After 1990 many countries adopted the Inflation Targeting Framework: Australia, Canada, Chile, Israel, Mexico, Brazil, New Zealand, Norway, South Africa, Peru, Sweden and the United Kingdom.
The Future Of Inflation Targeting
Inflation Targeting has become a widely adopted monetary framework for many countries after 1990. Many countries have successfully implemented the Inflation Targeting and many countries have not fixed their Inflation Targeting.
Looking to the future, Central banks are flexible to adapt Inflation Targeting and open new approaches to achieve policy objectives by addressing the certain limitations of the monetary framework.
Criticisms Of Inflation Targeting
Critics of Inflation Targeting argue that the monetary firework adopted by the Central Bank is not able to provide full employment and broad economic growth.
Inflation Targeting versus other monetary policy framework
There are several other monetary policy frameworks present they are; Exchange Rate Targeting, Monetary Agregate Targeting and Price Level Targeting. These monetary frameworks have their own advantages and limitations. These frameworks depended on the specific economic circumstances of a country.
Inflation Targeting and Financial Stability
Inflation Targeting adopted by many countries’ monetary framework, some critics argue that it can create or lead to financial instability.
Inflation Targeting mainly involves adjusting interest rates in response to change in Inflation Expectations. These Interest rate changes can also have broader effects on the economy by affecting the cost of lending and borrowing. When interest rates are set to low or high it can create financial imbalance or instability.
To address financial instability many Central banks have incorporated financial stability considerations, flexible Inflation targeting frameworks to maintain financial stability.
Inflation Targeting & Exchange Rates
Inflation Targeting also impacts on exchange rates. It impacts when a country has a higher interest rate than another country. It makes exports more expensive and also reduces economic growth of the country. However, many Central Banks are not directly targeting exchange rates for achieving their Inflation Targets.
Inflation Targeting & Fiscal Policy
Inflation Targeting also has an impact on fiscal policy of the country. When a Central Bank is focused to achieve its inflation target. It is difficult to accommodate the fiscal policy measures. So it can create Inflationary pressures and tensions between the Central Bank & the Government.
Inflation Targeting & Price Stability
Inflation Targeting is primarily focused on achieving price stability, that means it can keep inflation within a specific target range and prevent hyperinflation or deflation. Price stability is an important key factor for promoting long term economic growth and stability.