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inflation targeting

Page history last edited by Brian D Butler 11 years, 4 months ago

Inflation targeting....not in the USA....


While Bernanke favored an explicit target for inflation in the past -- something included in the mandates for other major central banks -- he has noted the political difficulty of instituting one for the Fed. Instead, he highlighted officials’ third year of predictions as a signal for policy objectives.


why not?  The governors want leeway to keep on expanding the Fed’s assets to absorb risk as financial markets remain unsettled.


Why is deflation so bad?


Deflation, or sustained declines in consumer prices, could further damage the economy by making debts more expensive to pay off and banks less willing to lend.  Read more in our page on deflation


New tools to fight deflation....."Quantitative easing"

Fed officials are “going to continue to buy assets, and they are going to try” to hold down longer-term Treasury yields 

read more here:  quantitative easing



Table of Contents:



inflation targeting


What is the right level for interest rates?  The "Taylor rule", which establishes the appropriate rate using the amount of spare capacity and inflation.



Why is it important?


Why is it important that a country has an independent central bank?


Because it allow them to do whats best to "target inflation"  with monetary policy, rather than doing whats best to help the politicians.   The troubles happen when politicians have their fingers in the central bank and can influence monetary policy.  No country will ever want slow growth and high unemployment (especially a democracy near election time!).  But, if inflation gets high, the best long term policy of the central bank is to raise interest rates to combat inflation.   The trouble is...that raising interest rates has the negative consequence of slowing down economic growth, and of raising unemployment (two things that politicians are lothe to do).  For this reason, it is essential that a country have independence of its central bank from the influence of meddling politicians!  Or else, as we have seen in country after country...inflation will get out of control, and there will be a crisis. 



For Investors in emerging markets


Look for countries with independent central banks, especially if you are going to operate in the country (see our discussion of FDI).   For example,  in Peru, the central bank is independent and is active in inflation targeting (which is not popular, but is good for fighting inflation).  So, in Peru, its unlikely that inflation will come back under 2nd Garcia’s presidency.



Countries that don't target inflation:


India:  see a link here where a reputable economist argues that India doesnt need to target inflation due to cultural contraints that will keep infation in line without it.  (controversial)




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