Compare and Contrast Inflation Targeting
Compare and contrast “inflation targeting” with the experience of the US Federal Reserve
Inflation targeting as the name suggests does not necessarily mean that the bank has only one agenda - correct rate of inflation to target. On the contrary, inflation targeting allows the central bank to have an explicit target for the rate of inflation which as a result helps the individuals, households and markets form inflation expectations for the future. Secondly, targeting inflation means that the central bank will place more weight on controlling inflation and keeping it within the boundary that they set. This target is very small and in Britain it is 2% ± 1%. However, the ECB sets an asymmetric target of <2% which of course coincides with the attitude that Germany has with inflation. Further, the US Federal Reserve has set its long-term inflation target between 1.7-2%. Finally, an explicit target allows the central bank to increase its transparency, be evermore independent in its actions. This forms a framework for price stability in the markets as well an opportunity to achieve short term goals for the economy.
Historically, the central banks or the government would control the growth rate of money supply but this in practise seems to be very inefficient and the result is higher inflation and output variability. Rudebusch and Svensson (2002) found that monetary targeting to be very inefficient for the Euro system. Their research was based on US data from the years 1986 to 1996. More importantly, they found that the federal funds rate moved very closely with the velocity of M2. However, after 1990 this relationship broke down the velocity of M2 increased significantly. Some of the reasons for this could be due to the increase in liquidity for bonds and stocks. Further, they point out that the strict money growth targeting does in fact lead to an increase in the variance of inflation. Yamada and Osaka (2013) found that whilst reviewing emerging and developing
Inflation targeting as the name suggests does not necessarily mean that the bank has only one agenda - correct rate of inflation to target. On the contrary, inflation targeting allows the central bank to have an explicit target for the rate of inflation which as a result helps the individuals, households and markets form inflation expectations for the future. Secondly, targeting inflation means that the central bank will place more weight on controlling inflation and keeping it within the boundary that they set. This target is very small and in Britain it is 2% ± 1%. However, the ECB sets an asymmetric target of <2% which of course coincides with the attitude that Germany has with inflation. Further, the US Federal Reserve has set its long-term inflation target between 1.7-2%. Finally, an explicit target allows the central bank to increase its transparency, be evermore independent in its actions. This forms a framework for price stability in the markets as well an opportunity to achieve short term goals for the economy.
Historically, the central banks or the government would control the growth rate of money supply but this in practise seems to be very inefficient and the result is higher inflation and output variability. Rudebusch and Svensson (2002) found that monetary targeting to be very inefficient for the Euro system. Their research was based on US data from the years 1986 to 1996. More importantly, they found that the federal funds rate moved very closely with the velocity of M2. However, after 1990 this relationship broke down the velocity of M2 increased significantly. Some of the reasons for this could be due to the increase in liquidity for bonds and stocks. Further, they point out that the strict money growth targeting does in fact lead to an increase in the variance of inflation. Yamada and Osaka (2013) found that whilst reviewing emerging and developing
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