How Inflation Expectations Influence Monetary Policy Effectiveness And Should Inflation Targeting
How Inflation expectations influence monetary policy effectiveness and should inflation targeting (IT) be adopted in China?
Introduction
After the 2008 financial crisis, to stimulate the economy and stabilize the prices, the Chinese central bank implemented a straightforward monetary policy. This policy consists of increasing money supply and lowering interest rates, which presented a risk of inflation. According to National Bureau of Statistic (NBS) data, there has been a 2.5% increase in Consumer Price Index (CPI) in January 2014, but 55.8% of the Chinese people think the inflation will sharply increase. The difference between real and expected inflation has prompted the central bank to consider how inflation expectation play a role in the process of monetary policy implementation and conduct.
Based on the history of monetary policy in USA, Orphanides and Williams(2004) have found that the change of public expected inflation will result in the failure of monetary policy. To manage uncertain predictions, many developed countries, such as Britain, have adopted inflation targeting (IT) regime instead of conventional one. IT regime means the central bank takes monetary tools forward to certain inflation level for economic stability (Mishkin, 2000). He claims that it is useful to decrease the inflation fluctuation and maintain outcomes by adopting IT, although there is no certain evidence to show its improvement in outcomes (Ball and Sheridan, 2004). To reduce influence of inflation expectations on price stability and economic growth, it is necessary and available to adopt inflation-targeting regime in China, despites imperfect institutional independence, financial system, economic structure and technical infrastructure.
This essay will begin with the discussion about interaction between inflation expectations and monetary policy effectiveness, followed by identifying the features of inflation expectations. The essay will then focus on what benefits inflation
Introduction
After the 2008 financial crisis, to stimulate the economy and stabilize the prices, the Chinese central bank implemented a straightforward monetary policy. This policy consists of increasing money supply and lowering interest rates, which presented a risk of inflation. According to National Bureau of Statistic (NBS) data, there has been a 2.5% increase in Consumer Price Index (CPI) in January 2014, but 55.8% of the Chinese people think the inflation will sharply increase. The difference between real and expected inflation has prompted the central bank to consider how inflation expectation play a role in the process of monetary policy implementation and conduct.
Based on the history of monetary policy in USA, Orphanides and Williams(2004) have found that the change of public expected inflation will result in the failure of monetary policy. To manage uncertain predictions, many developed countries, such as Britain, have adopted inflation targeting (IT) regime instead of conventional one. IT regime means the central bank takes monetary tools forward to certain inflation level for economic stability (Mishkin, 2000). He claims that it is useful to decrease the inflation fluctuation and maintain outcomes by adopting IT, although there is no certain evidence to show its improvement in outcomes (Ball and Sheridan, 2004). To reduce influence of inflation expectations on price stability and economic growth, it is necessary and available to adopt inflation-targeting regime in China, despites imperfect institutional independence, financial system, economic structure and technical infrastructure.
This essay will begin with the discussion about interaction between inflation expectations and monetary policy effectiveness, followed by identifying the features of inflation expectations. The essay will then focus on what benefits inflation
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