Inflation targeting

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Inflation targeting
Inflation targeting is a monetary policy strategy that encompasses five main elements: 1) the public announcement of medium-term numerical targets for inflation; 2) an institutional commitment to price stability as the primary goal of monetary policy, to which other goals are subordinated;

Inflation targeting
3) an information inclusive strategy in which many variables, and not just monetary aggregates or the exchange rate, are used for deciding the setting of policy instruments;
4) increased transparency of the monetary policy strategy through communication with the public and the markets about the plans, objectives, and decisions of the monetary authorities; and
5) increased.2 accountability of the central bank for attaining its inflation objectives.

Inflation targeting
The list should clarify one crucial point about inflation targeting: it entails much more than a public announcement of numerical targets for inflation for the year ahead. This is important in the context of emerging markets’ countries because many of them routinely reported numerical inflation targets or objectives as part of the government's economic plan for the coming year, and yet their monetary policy strategy should not be characterized as inflation targeting, which requires the other four elements for it to be sustainable over the medium term.

Advantages of Inflation Targeting
Inflation targeting
Inflation targeting has several advantages as a medium-term strategy for monetary policy. In contrast to an exchange rate peg, inflation targeting enables monetary policy to focus on domestic considerations and to respond to shocks to the domestic economy. In contrast to monetary targeting, another possible monetary policy strategy, inflation targeting has the advantage that a stable relationship between money and inflation is not critical to its success: the strategy does not depend on such a relationship, but instead uses all available information to determine the best settings for the instruments of monetary policy.

Inflation targeting
Inflation targeting also has the key advantage that it is easily understood by the public and is thus highly transparent. Because an explicit numerical target for inflation increases the accountability of the central bank, inflation targeting also has the potential to reduce the likelihood that the central bank will fall into the time-inconsistency trap. Moreover, since the source of time-inconsistency is often found in (covert or open) political pressures on the central bank to undertake overly expansionary monetary policy, inflation targeting has the advantage of.3 focusing the political debate on what a central bank can do in the long-run -- i.e., control inflation -- rather than what it cannot do -- raise output growth, lower unemployment, increase external competitiveness-- through monetary policy.

Inflation targeting
For inflation targeting to deliver these outcomes, there must exist a strong institutional commitment to make price stability the primary goal of the central bank. This is particularly important in emerging market countries which have often had a past history of monetary mismanagement. The institutional commitment involves legislative support for an independent central bank whose charter ought to contain two key features:

Inflation targeting
1) sufficient insulation of the policymaking board of the central bank from the politicians--with members of the government excluded and the members of the board appointed to long terms and protected from arbitrary dismissal; and
2) giving the central bank full and exclusive control over the setting of monetary policy instruments. The institutional commitment to price stability also requires that the central bank be given a mandate to have price stability as its primary goal, making it clear that when there is a conflict with other goals, such as exchange rate stability or promotion of high employment, price stability must be accorded the higher priority.

Inflation targeting
Inflation-targeting regimes also put great stress on the need to make monetary policy transparent and to maintain regular channels of communication with the public; in fact, these features have been central to the strategy's success in industrialized countries. As illustrated in Frederic Mishkin and Adam Posen (1997), and in Ben Bernanke, Thomas Laubach, Frederic Mishkin and Adam Posen (1999), inflation-targeting central banks have frequent communications with the government, and their officials take every opportunity to make public speeches on their monetary policy strategy. Inflation targeting central banks have taken public outreach a step further: they publish Inflation Report-type documents (originated by the Bank.4 of England) to clearly present their views about the past and future performance of inflation and monetary policy.

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