Inflation Targeting—COUNTRY CASE STUDIES
-(I) New Zealand (effective in 1990)
------Inflation was brought down and remained within the target most of the time.
------Growth has generally been high and unemployment has come down significantly
------Small economy with extensive social welfare system, high public investments in education, job training and relatively solidaristic incomes policies.
-(II) Canada (1991)
------Inflation decreased since then, some costs in term of unemployment
------Economy halfway between social democracy and the US system
-(III) United Kingdom (1992)
------Inflation has been close to its target.
------Growth has been strong and unemployment has been decreasing.
------Broad although not too generous social welfare system; increasingly moving toward the US model of rugged market system, privatization of many socialized sectors, large immigration, London as international destination for large fortunes in real estate, etc. Part of EU since 1970s benefitted greatly its financial services sector.
FIG. 1: Inflation Rates & Inflation Targets: N.Z., Canada, USA
Inflation Targeting-- ADVANTAGES & DISADVANTAGES
-Advantages
------Does not rely on one variable to achieve target
------Easily understood
------Reduces potential of falling in time-inconsistency trap
------Stresses transparency and accountability
-Disadvantages
------Delayed signaling
------Too much rigidity
------Potential for increased output fluctuations
------Low economic growth during disinflation
======================================================
pp.408-410
MONETARY POLICY WITH AN IMPLICIT NOMINAL ANCHOR
-There’s no explicit nominal anchor in the form of an overriding concern for the Fed.
-Forward looking behavior and periodic “preemptive strikes”
-The goal is to prevent inflation from getting started.
Monetary Policy & Implicit Nominal Anchor-ADVANTAGES & DISADVANTAGES
-Advantages
------Uses many sources of information
------Avoids time-inconsistency problem
------Demonstrated success
-Disadvantages
------Lack of transparency and accountability
------Strong dependence on the preferences, skills, and trustworthiness of individuals in charge
------Inconsistent with democratic principles
====================================================
See Summary Table 1: Summary of all these: Monetary Targeting vs. Inflation Targeting vs. Implicit Nominal Anchor---Their ADVANTAGES & DISADVANTAGES
=======================================================
pp.412-414
FIG. 1: LINKAGES between CB (I) TOOLS, (II) POLICY INSTRUMENTS, (III) INTERMEDIATE TARGETS, and (IV) GOALS
*TACTICS: CHOOSING THE POLICY INSTRUMENT
ToolsèPolicy InstrumentèIntermediate TargetsèGoals
I. TOOLS
------Open market operation
------Reserve requirements
------Discount rate
II. POLICY INSTRUMENT (operating instrument)
------Reserve aggregates (reserves, NBR, Monet. Base, non-borrowed base)
------Interest rates (short term; e.g. fed funds rate…… Fig. 3: Result of Targeting on Non-Borrowed Reserves (NBR)
------(These may be linked to an intermediate target )
=={KEY Quandary in with Policy Instruments to Achieve Intermediate Targets: Interest-rate and aggregate targets are incompatible.} (CB must chose one or the other but can’t achieve both). Fig.3 and Fig. 4 (Result of Targeting on the Federal Funds Rate (Interbank Lending Rate)) show this problem.
III. INTERMEDIATE TARGETS
------Monetary Aggregates (M1, M2)
------Interest rates (short term; e.g. fed funds rate
------May be linked to an intermediate target
IV. GOALS
------Price Stability (reduced uncertainty about prices)
------High Employment (reduced uncertainty about incomes of households)
------Economic Growth (reduced uncertainty about future incomes, opportunities)
------Financial Market Stability (Systemically stable)
------Interest rate Stability (reduced uncertainty about prices)
------Foreign Exchange Market Stability (reduced uncertainty re: FX prices)
This outline above is displayed in a choices/causes/effects graphic in Fig.2:
Tools -> Policy Instruments -> Intermediate Targets -> Goals
==============================================
p.413
*CRITERIA FOR CHOOSING THE POLICY INSTRUMENT
------Observability and Measurability
------Controllability
------Predictable effect on Goals
==============================================
pp. 414-416
*The Taylor Rule, (a) NAIRU (“natural” market rates of unemployment) theory, and the PHILLIPS CURVE (correlation between unemployment & inflation) theory
=>TAYLOR RULE TO SET the Federal funds target rate = Sum of the following:
-------(1) Inflation rate
-------(2) Equilibrium fed funds rate
-------(3) (1/2)x(inflation gap)
-------(4) (1/2)x(output gap)
Taylor assumed the concepts of:
=(a) An inflation gap and
=(b) an output gap
------Stabilizing real output is an important concern
------Output gap is an indicator of future inflation as shown by Phillips curve ‘theory’ or statistical relationship
and the so-called NAIRU theory (non-accelerating-inflation rate of unemployment---a ‘natural’ result of market system)
------NAIRU is the Rate of unemployment at which there is no tendency for inflation to change
Fig. 5: The Taylor Rule for the Fed funds rate, 1970-2008
(Mishkin believes it shows something clearly, but it is not made clear why he thinks so since evidence is lacking, although, since he appears to have helped put it into practice at the Fed, he sees some merit in it perhaps.}
====================================================