Who Benefits from Inflation
Targeting?
"[W]hat really matters for
successful monetary policy is establishing a strong nominal anchor. While
inflation targeting is one way to achieve this, it is not the only way."
NBER Research Associate Frederic
Mishkin and co-author Klaus Schmidt-Hebbel review the pros and cons
of inflation targeting in Does Inflation Targeting Make A Difference? (This
work -- published in NBER Working Paper No.
12876:http://www.nber.org/papers/w12876.pdf ) - was completed before Mishkin
became a member of the Board of Governors
of the Federal Reserve System.) Developing - or emerging - nations with high
inflation benefit the most from the practice, the study finds. For mature,
developed nations like the United States, the benefits are far more subtle.
Many nations are warming to the
idea of inflation targeting. By 2005, for example, eight industrial economies
and 13 emerging ones had adopted full-fledged inflation targeting. Many others
expect to make the move soon. But the case for inflation targeting has not been
open and shut.
While studies have generally
established a link between the practice and improved economic performance, they
haven't proven that the former causes the latter. Indeed, stable and mature
non-targeting nations, including the United States, have often done just as
well or better
without it. "[T]he ongoing debate on whether inflation targeting matters
indicates that open questions remain, particularly on the comparative
macroeconomic performance in inflation targeting countries, both over time and
relative to nontargeting countries," write the authors of this study.
"[W]hat really matters for successful monetary policy is establishing a
strong nominal anchor. While inflation targeting is one way to achieve this, it
is not the only way."
By looking carefully at a broad
sample of 21industrial and emerging-economy inflation-targeting countries over
time, and comparing them with a control group of 13 industrial non-targeters,
the authors conclude that a target does indeed improve economic performance but
the effects vary dramatically depending on the type of economy that attempts
it.
For example: targeters trimmed
their inflation rates from an average 12.6 percent before they adopted the
practice to 4.4 percent after they did. Emerging economies saw the biggest drop
- to 6 percent after they began targeting inflation. Developed industrial
targeters saw a smaller decline but achieved a much lower rate of inflation: an
average 2.2 percent. That impressive rate was bested, however, by developed
non-targeters, who have averaged 2.1 percent since 1997. So the practice seems
to provide the biggest help to nations that are struggling the hardest to tame
inflation, while its effects on nations with more benign price appreciation are
relatively small, sometimes negligible.
Take, for instance, an economy's
reaction to an outside shock, such as a spike in oil prices. Targeting helps to
reduce the inflationary impact in a given country, apparently because the
practice enhances the central bank's credibility and stabilizes consumer
expectations. But like the drop in inflation, the benefit varies.
Targeting nations, especially
emerging governments that have achieved their inflation target, see the biggest
improvement, according to the study. These economies actually see less impact
from oil shocks than do non-targeting nations. By contrast, non-targeting
nations seem to weather better an external shock caused by a sudden change in
exchange rates.
Targeting can also help emerging
nations go against the flow when inflation is raging worldwide, this study
finds. The results are striking: currencies were 10 times less sensitive to
foreign inflation after the host country had adopted targeting. And, they saw a
further decline once they had tamed inflation. Curiously, more developed
nations saw an increase in the inflation vulnerability of their currencies
after adopting targeting, albeit at a much lower level than emerging nations.
Finally, this study looks at
whether targeting makes economies work more smoothly - with more stable
inflation and growth. Again, the results vary. Emerging nations made the
biggest strides once they adopted targeting. Industrial targeters saw a slight
improvement, but only because they faced smaller shocks to their economies in
the first place. But, developed non-targeters did even better on both measures
of economic efficiency.
The benefits of inflation targeting
for non-targeting countries with low inflation and efficient economies are less
obvious. The lack of a target does reduce transparency and raise uncertainty.
Over the long term, the lack of a target also could reduce the credibility of a
central bank if it's not seen as being held accountable to a standard. While it
is wrong to say that inflation targeting always helps, the authors conclude, it
doesn't seem to hurt in too many cases and may help to stabilize inflationary
expectations in an uncertain future.
-- Laurent Belsie: http://www.nber.org/digest/septoct07/w12876.html
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