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Unit 2 IP

Name

Institution
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Inflation targeting

Inflation targeting is a monetary policy framework by the central bank aimed at keeping

the inflation rate at a particular annual rate. The principle of inflation targeting has its basis on

controlling price stability, which in turn spurs economic growth. Usually, by setting inflation at a

certain percentage, consumers think that the price of goods and services will continue rising

hence buy more, thus leading to economic growth (Svensson, 2010). Economic growth in a

country can be created by either lowing the interest rate or reducing taxes and increasing

spending, all of which can be used in inflation targeting. 

Advantages and disadvantages of inflation targeting

Inflation targeting ensures that calm, predictability and a sense of normalcy get achieved.

Since we live in an unpredictable economic world where people lose jobs and businesses open

and shut without warning, then the situation can easily become disorganized if left unmanaged.

Therefore inflation targeting ensures that the inflation is managed, making organizations and

people know what to expect. Disasters are also averted by inflation, targeting by preventing

numerous economic booms (Svensson, 2010). The supply and demand principle is essential in

economics. Therefore if organizations are left to manage their selling prices, the world would

continuously experience various economic booms. Therefore, inflation targeting ensures that

inflation is checked to avoid unsupported growth, which usually leads to the bursting of bubbles.

Inflation targeting also controls the rise in the price of commodities and services. If left

unmanaged, prices can rise to an unimaginable level making it difficult to purchase essential. If

the prices rise to an unrealistic level, there will be numerous economic chaos like those currently

being experienced in Venezuela.

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Other than the above advantages, inflation targeting is also associated with various

disadvantages. Critics of inflation targeting argue that various factors naturally influence the

economy, and thus it is not possible to manage the economy by controlling a few elements.

Therefore by trying to control the inflation rate, government and financial institutions at times

end up having more problems like the 2008 financial crisis (Svensson, 2010). Inflation targeting

is also seen as a move against development since major developments are usually associated with

inflation in various parts of the world. In the long term, inflation targeting May make lead to

uncompetitiveness in some industries. This is because the inflation targeting leads to poor

welfare policies, fiscal deficits, and eventually stopping the free flow of the economy. Those

against inflation targeting encourage the use of nominal GDP targeting or rate targeting for better

economic stability.

Compare and contrast the inflation targeting in the United Kingdom, Canada, and

New Zealand.

New Zealand, United Kingdom and Canada, are some of the countries that adopted

inflation targeting in the early 1990s. Canada first announced its targets in 1991 with target

bands whose width was 2 percent, and its midpoint was expected to drop to 3 percent, 2.5

percent and 2 percent at the end of 1992, mid-1994 and end of 1995, respectively. Since 1995

Canada's target for the annual rate of CPI is 2% midpoint of a 1 to 3 percent range. Bank of

Canada target scheme-specific price index utilized (CPI) consumer price index excluding energy,

food, and indirect taxes changes contribution.

New Zealand was the first country to formally set an inflation targeting with a range of 0-

2 percent, thus setting the stage for other countries. The institutionalization of inflation targeting

was facilitated by the reserve bank of New Zealand (RBNZ) act of 1989 and the provision that a
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governor may be fired if the inflation rate goes outside the set target band (Gürkaynak et al.,

2010). The price stability target is defined by all the group's CPI, which is a computation that is

strictly observed by the public.

The UK adopted inflation targeting without government involvement in September 1992

after the exchange rate peg collapse to ECU. The initial retail price index was 1-4 percent and

excluded the mortgage interest component, but it was expected to go below less than 2.5 percent

by the spring of 1997 latest (Gürkaynak et al., 2010). Four major institutional changes occurred,

and since then, money market conditions are loosened when inflation is expected to fall away

from the target scope, which has a width of 2 percent.

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References

Gürkaynak, R. S., Levin, A., & Swanson, E. (2010). Does inflation targeting anchor long-run

inflation expectations? Evidence from the US, UK, and Sweden. Journal of the European

Economic Association, 8(6), 1208-1242.

Svensson, L. E. (2010). Inflation targeting. In Handbook of monetary economics (Vol. 3, pp.

1237-1302). Elsevier.