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FRED data. My bibliography Save this book chapter. While there have been numerous studies of inflation targeting in industrial countries, there has been much less analysis of the effects of inflation targeting in emerging market countries.
Based on a new and detailed survey of 31 central banks, this paper shows that inflation targeting in emerging-market countries brings significant benefits to the countries that adopt it relative to other strategies, such as money or exchange rate targeting. Indeed, by comparing the performance of the inflation-targeting countries with a sample of countries that pursue other regimes we show that there are significant improvements in anchoring both inflation and inflation expectations with no adverse effects on output.
In addition, under inflation targeting interest rates, exchange rates, and international reserves are less volatile, and the risk of currency crises relative to money or exchange rate targets is smaller. Interestingly, IT seems to outperform exchange rate pegs—even when only successful pegs are chosen in comparison. The target is set by Government officials in a Memorandum of Understanding between the Government and Bank Indonesia, the inflation target is established for three year period in a Decree of the Minister of Finance KMK.
The implementation of IT, as explained by the Bank Indonesia, emphasizes the importance of setting a target that is easily understood by the public.
It describes the process accordingly:. The Bank Indonesia announces future inflation targets for specific periods. During each period, Bank Indonesia will evaluate whether the inflation projection is on track with the adopted target. This projection employs a number of models and various information depicting future inflation conditions. If the inflation projection is no longer compatible with the target, Bank Indonesia then responds with the instruments at its disposal.
For example, if the inflation projection overshoots the target, Bank Indonesia will adopt a tight bias monetary policy. Bank Indonesia issues regular explanations to the public on the assessment of inflation conditions, the future outlook and decisions taken. If the inflation target is not reached, an explanation must be provided to the public and measures taken to put inflation back on course for its target.
With an explicit inflation target, the public will understand the direction of inflation. In contrast, when a base money target is employed, the public has greater difficulty in understanding the future direction of inflation, especially if the linkage with inflation is unclear. The ITF focuses on inflation as the monetary policy priority, in keeping with the mandate vested in Bank Indonesia.
The ITF is forward looking, as appropriate to the time lag for policy to have impact on inflation. The ITF strengthens the transparency and accountability of monetary policy and in so doing boosts monetary policy credibility. Transparency, accountability and clarity of objectives form part of the good governance of a bank vested with independence. The ITF does not require an assumption of stability in the relationship between money supply, output and inflation. Instead, the ITF represents a more comprehensive approach that takes account of a number of information variables on the condition of the economy.
The IT regime in Israel was one of the first in the world. According to the central bank, the main objective of monetary policy is to maintain price stability in order to help to create a business environment that supports sustainable economic growth. Price stability is defined in terms of an inflation target that the government has been setting since The objective of monetary policy is to attain the target. To attain the inflation target, the Bank of Israel sets the level of short-term interest rates.
Too low a level of interest would lead to overexpansion and inflationary pressures, while too steep a rise in the rate of interest would result in excessive restraint of economic activity. Monetary policy, through the interest rate, also affects inflation expectations of the public individuals and companies and through them the decisions the public makes on the basis of those expectations. Experience in Israel and abroad shows that inflation has a distorting effect on vital aspects of the economy-production, consumption, foreign trade, the labor market, and the financial markets-to the detriment of stable economic growth.
Hence the importance that the Bank of Israel like other central banks attaches to the battle against inflation. Each month, the Bank of Israel determines the interest rate level that is needed to maintain price stability or to converge into the range defined as price stability within a reasonable period of time , and to support financial stability, and attain the government's other objectives, primarily growth and employment.
To make this decision and as a basis for formulating monetary policy, the Research Department and Market Operations Department formulate an outline of the state of the inflation environment and the forces that affect it by analyzing current information about activity, the labor market and prices, capital market indicators, and using quantitative empirical models that the Bank has developed to predict inflation.
The website contains additional descriptions of specific policy instruments e. One of the few countries in the sample that has a stated primary goal other than inflation targeting is Mexico. According the central bank's website, the main goal of Banco de Mexico is "to preserve the value of Mexico's currency in the long term in order to improve Mexicans' well-being. Banco de Mexico's autonomy rests on three pillars. The first is a legal pillar consisting of a constitutional mandate which establishes that its main priority is to foster the currency's purchasing power.
The second pillar consists of the integration of its Governing Board and the rules by which it operates. This collegiate body comprises a governor and four deputy governors who are appointed by the President but cannot be removed from their post at his discretion.
They serve alternately. The governor serves for six years, starting in the middle of a six-year presidential term and ending after the first three years of the following presidential term. Deputy governors serve for eight years and are replaced alternately every two years.
The third pillar is the administrative autonomy the law confers on the central bank. Significant progress in monetary policy has been made since the middle of the last decade with the adoption of a benchmark rate the overnight interbank funding rate as Banco de Mexico's monetary policy instrument.
Since April , monetary policy announcements were setting minimum interest rates and so the market was already operating "de facto" following the rate indicated by Banco de Mexico. Thus, formal migration to a benchmark rate operational target was implemented without altering the way in which Banco de Mexico had been operating. This change also facilitated the understanding of monetary policy actions and brought its implementation into line with that of other central banks.
In contrast to Mexico, Peru has basic definitions of policy instruments and basic economic explanations on its central bank's BCRP website. The BCRP website is one of the most informative in terms of policy making and transparency.
For example, on inflation: "Inflation is detrimental to economic development because it prevents money from adequately fulfilling its functions as a medium of exchange, as a unit of account, and as a store of value. Inflation discourages investment and promotes speculation because it generates distortions in the price system, as well as an inefficient allocation of resources.
The devaluation of money resulting from generalized and continuous rises in the prices of goods and services affects mainly low-income groups as these groups have usually no easy access to inflation hedging mechanisms. Thus, by maintaining inflation low, the BCRP creates the necessary conditions for normal economic activity which, in turn, contributes to achieving higher levels of sustained economic growth. There are series of FAQs on the website which describes the basic function of the central bank.
What does the BCRP independence consist of? What is the highest authority of the BCRP? What is the BCRP inflation target? Why did the BCRP reduce its inflation target from 2. What is the interbank interest rate? What type of dollarization is there in the Peruvian economy? Why does the BCRP carry out foreign exchange operations?
The inflation target is continuously measured against the lastmonth Consumer Price Index CPI for Metropolitan Lima to evaluate if the target has been met.
Should inflation deviate from the target range, the Central Bank will take any necessary action to make it return to the target range, taking into account the lags of monetary policy.
In order to achieve price stability, the Central Bank seeks to prevent possible deviations of inflation vis-a-vis the target on a timely basis, given that BCRP's monetary decisions will affect inflation only after some quarters. Monetary policy actions consist of modifying the reference interest rate for the interbank market, just like the other central banks following this scheme do.
Depending on whether inflationary or deflationary pressures are observed in the economy, the BCRP will preventively modify the reference interest rate to maintain inflation at the target level.
At the beginning of every year, the BCRP publishes the dates when the Board of the Central Bank will make monetary policy decisions usually at the first meeting of the Board every month. The Board's agreements and decisions are then immediately announced to the public through press releases explaining the main reasons that support said decisions. In order to generate credibility regarding the inflation target and contribute to anchor inflation expectations, it is important that the BCRP inform the public how it intends to meet the target, as well as the arguments explaining the Central Bank's decisions.
This document, which is also found on the Bank's web site, analyzes the recent evolution of inflation and the actions adopted by the Central Bank, as well as the Banks vision on the evolution of economic variables and on how they might influence on inflation's future trend. Moreover, the Inflation Report also examines the main factors that could deviate inflation one way or another, which is called risk balance.
The BCRP monetary decisions are taken in a transparent manner, in line with the inflation target, taking into account the forecasts published in the Inflation Report. Therefore, the monthly press releases on the monetary program for the month are usually based on the Inflation Report or refer to it. The BSP makes the announcement of the inflation target two years in advance. Begninning in , the BSP announced a shift to a fixed inflation target for the medium term, beginning with a target of 4.
Inflation targeting is an approach to monetary policy that involves the use of a publicly announced inflation target set by the Government, which the BSP commits to achieve over a two-year horizon. Promoting price stability is the BSP's main priority, and the target serves as a guide for the public's expectations about future inflation, allowing them to plan ahead with greater certainty.
The Advisory Committee was established as an integral part of the institutional setting for inflation targeting. It is tasked to deliberate, discuss and make recommendations on monetary policy to the Monetary Board. It consists of a rate at which the central bank CB lends to banks typically an overnight lending rate and a rate at which it takes deposits from them deposit rate. IT is set by the Monetary Policy Council which describes the basic objective of monetary policy as "maintaining price stability" and that "stable prices are an indispensable element of constructing solid foundations for long-term economic growth.
Since the direct inflation target strategy has been utilized in the implementation of monetary policy. Within the framework of this strategy, the Monetary Policy Council defines the inflation target and then adjusts basic interest rates in order to maximise the probability of hitting the target.
The NBP maintains interest rates at a level consistent with the adopted inflation target by influencing the level of nominal short-term interest rates on the money market. Money market rates affect loan and deposit rates at commercial banks and thus the size of loans, the demand within the economy and the inflation rate. The set of monetary policy instruments used by the NBP enables it to determine interest rates on the market.
These instruments include open market operations, reserve requirements and credit-deposit operations. Since the introduction of the flexible inflation-targeting framework in February , the specification of the target has been reviewed on a number of occasions. The initial target measure was the CPIX, which was defined as the consumer price index for metropolitan and other urban areas, excluding the interest cost on mortgage bonds.
This variant of the CPI was chosen because the headline or overall CPI was at that time influenced directly by changes in the Banks monetary policy. However, following revisions to the methodology employed to compile the CPI, which resulted in, inter alia, a change in the treatment of housing, mortgage interest costs no longer needed to be removed from the CPI when evaluating the effects of monetary policy.
When inflation targeting was introduced, the first target was specified as a calendar year average for for CPIX inflation. Subsequent targets were also specified in terms of an average for a particular calendar year. In November the Minister of Finance announced that the calendar-year averaging would fall away and that the target would apply continuously. The central bank website makes clear that in "monetary policy decision-making processes, committees are preferred above individuals.
Not one central bank has replaced a committee with a single decision-maker, a fact that has both theoretical and empirical support; the ability to draw diverse viewpoints from constituent members in committees ensures that there is likely to be some moderation of extreme positions and policies and more even policymaking.
Policy is set by the Monetary Policy Committee MPC , which consists of eight members of the Bank: the Governor, three deputy governors and four senior officials of the Bank. South Africa's commitment to transparent monetary policy has resulted in several initiatives to improve the communication of its policies to the public. According to the central bank, "this Review is aimed at broadening the understanding of the intentions and conduct of monetary policy.
Moreover, the Review analyses the domestic and international developments that have impacted on inflation and motivates the monetary policy reaction to these developments. An assessment of the future outlook for the factors determining inflation as well as the Bank's forecast of the future path of inflation is provided in the MPR.
The Bank of Thailand Act explicitly states Thailand's monetary policy framework as:. By December of each year, the Monetary Policy Board, with a corporative agreement with the Minister, shall determine targets of monetary policy for the following year which shall be regarded as the guideline for the State and the BOT for the purpose of implementing any measure to maintain the price stability. The Minister shall propose the agreed targets of monetary policy to the Cabinet for approving.
Upon the approval, it shall be published in the Government Gazette. Despite the success of the inflation targeting framework with the core inflation as policy target in achieving price stability since its beginning in , some important deficiencies with the core inflation may diminish its effectiveness going forward. Compared to core inflation, headline inflation is better in reflecting more accurately the change in the cost of living since it captures changes in prices of all goods and services in the CPI basket, including raw food and energy prices which account for 27 percent of the CPI basket.
Therefore, headline inflation is more in tune with the understanding of general public of what constitutes the cost of living, and has been widely used as reference for saving decisions by households and for investment and price setting decisions by businesses. In addition, in recent years, core inflation has somewhat lost its ability to track overall inflationary pressure as it has diverged from headline inflation for much longer time period, compared to the past.
This is likely because changes in raw food and energy prices have increasingly more influence on the inflation dynamics over the past decade. Lastly, it is in line with international practices, with all countries under the inflation targeting framework currently use headline inflation as policy target.
Therefore, adopting headline inflation as policy target will improve the efficiency of central bank's communication with the public and thus strengthen the monetary policy effectiveness in anchoring long term inflation expectations.
Changing from the range of 0. It prevents them from mistaking the bounds as target. Thus, point target should help anchor long term inflation expectation more effectively. This section examines the rate of inflation in the 14 countries before and after inflation targeting IT.
Two observations are made. First, the rate of inflation came down significantly in all countries around the adoption date of IT. Given that the countries are diverse and the date of implementation was different in each country, it is obvious that IT was successful along this dimension.
The second set of figures documents the inability of the central banks to hit the inflation target over the medium run. This poses the greatest challenge for IT going forward. The first set of figures plots the year-over-year change in the rate of inflation six to eight years before IT, and several years following IT.
The implementation date of IT was found on central bank websites In some cases, like Chile, an inflation target was gradually introduced. Sources: OECD. Figure 1: Inflation Targeting.
If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form. If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation. For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Claudio Sepulveda email available below.
Please note that corrections may take a couple of weeks to filter through the various RePEc services. Economic literature: papers , articles , software , chapters , books. FRED data. My bibliography Save this paper. The Experience of Emerging Markets. While there have been numerous studies of inflation targeting in industrial countries, there has been much less analysis of the effects of inflation targeting in emerging market countries.
Based on a new and detailed survey of 31 central banks, this paper shows that inflation targeting in emerging-market countries brings significant benefits to the countries that adopt it relative to other strategies, such as money or exchange rate targeting. Indeed, by comparing the performance of the inflation-targeting countries with a sample of countries that pursue other regimes we show that there are significant improvements in anchoring both inflation and inflation expectations with no adverse effects on output.
In addition, under inflation targeting interest rates, exchange rates, and international reserves are less volatile, and the risk of currency crises relative to money or exchange rate targets is smaller. Interestingly, IT seems to outperform exchange rate pegs—even when only successful pegs are chosen in comparison.
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