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Inflation targets don't kill jobs, economies


Are central banks dealing with inflation as if they were hunting bears with a howitzer? The simple answer is no, though a growing number of academics will say otherwise.

Six industrialised nations and at least 20 developing ones use inflation targeting as the cornerstone of their monetary policies. Eight others, including the Federal Reserve, European Central Bank and Bank of Japan, unofficially target inflation, according to Morgan Stanley. Yet, the strategy is too restrictive, bordering on mechanistic, critics say. And by rigidly focusing on inflation, it ignores other central bank responsibilities, such as growth , employment and financial market stability.

“The struggle to meet rising food and energy prices is hard enough,” Joseph Stiglitz, a professor at Columbia University and the winner of the ’01 Nobel Prize in Economics, said in a recent paper. “The weaker economy and higher unemployment that inflation targeting brings won’t have much effect on inflation; it will only make the task of surviving in these conditions more difficult.”

The bottomline is: developing and developed countries should abandon inflation targeting, he said. Not so fast. With a target, a government or central bank identifies a specific inflation level or range it wishes to achieve and explicitly acknowledges that low and stable inflation is the paramount goal of monetary policy, said Fed chairman Ben Bernanke and Fed governor Frederic Mishkin in a 1997 paper they co-wrote .

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Other attributes of inflation targeting include stepped-up public communication of the bank’s aims and in increased accountability for attaining those objectives .

Anchoring monetary policy around a well-thought-out inflation target is better than none at all, which may leave markets confused. It helps to insulate a central bank from political interference, while enhancing its credibility. A target also provides explicit criteria against which to measure monetary policy and a central bank’s performance.

And it helps institutionalise sound policy. That hasn’t silenced the critics. “Inflation targeting can promote damaging mechanical policy making, as happened with money-supply targeting in the late 1970s,” Thomas Palley, head of the Economics for Democratic & Open Societies Project, wrote. Inflation-targeting central banks have tended to select a low target, when a slightly higher one may lead to “higher real wages, lower unemployment and possibly faster growth.”