Has Inflation Targeting Been Effective

I. INTRODUCTION Since the 1990s, about 30 countries have adopted inflation targeting as their framework for the conduct of monetary policy. Countries that have adopted inflation targeting have generally shown good economic performance, including low inflation and stable economic growth. Price stability is one of the most important assignments for policymakers, especially those in central banks, regardless of whether or not inflation targeting is adopted. Several instruments, including inflation targeting, monetary targeting, and exchange rate targeting, are employed to achieve price stability in many countries worldwide. Among these tools, inflation targeting has been used recently. Since the 1990s, policymakers have become increasingly concerned with inflation stabilization. The increased focus on inflation stabilization has contributed to the reduction of inflation rates from the high rates experienced in the 1970s and 1980s. This paper discusses why countries adopt inflation targeting and how they have attained economic performance by introducing inflation targeting. Section II explains recent trends and innovations in inflation targeting. Section III presents a theoretical view and an empirical method for the examination of why inflation targeting has been introduced. Section IV shows the empirical results and analyzes them. Section V analyzes whether the introduction of inflation targeting has reduced the costs of inflation stabilization, the accumulated output loss due to a reduction in inflation. Finally, this paper ends with a brief summary. II. WHAT IS INFLATION TARGETING? In general, inflation targeting is a policy by which central banks publicly set the target rate for inflation; monetary policy is then carried out according to this target (Fountas et al., 2002; Kurihara, 2003). It has not been long since inflation targeting was first adopted as a monetary strategy. The United States has not yet adopted inflation targeting, although the US Congress has considered it, especially in 2002. The Bank of Japan also does not have a policy of inflation targeting. The ECB does not admit the existence of inflation. However, inflation targeting might be substantially adopted. With inflation targeting, central banks are responsible for achieving a publicly announced objective for the inflation rate. Recently, about 30 central banks all over the world adopted this framework for the conduct of monetary policy, which has proven effective in most cases (Svensson et al., 2005). Mishkin (2001) noted that countries that practice inflation targeting have attained a significant reduction in both the rate of inflation and inflation expectations beyond that which would likely have occurred in the absence of inflation targeting. Many other benefits can be obtained from the introduction of inflation targeting. First, the realization of the central bank's goal of price stability might not be judged accurately in the absence of clear standards. By introducing targeting, markets can accurately judge the performance of central banks. Second, clarification and increased transparency of central banks' goals guarantees accountability for the target and independence from the government. Third, this approach confers stability of the expected inflation rate. Targeting locks in expectations of low inflation, which reduces the inflationary impact of macroeconomic shocks (Svensson, 1997). (1) Finally, inflation in countries that have introduced the policy has been reduced as mentioned before. On the other hand, many critical perspectives have been presented. First, because controlling inflation using money supply growth or exchange rate may be less effective, trust in a commitment to inflation targeting may be unstable. Second, if market participants believe and credit the target, there is some possibility of increases in long-term interest rates, for example. Third, targeting may be attained at the sacrifice of other important economic factors. …