Conduct of Monetary Policy
Inflation targeting is an economic policy through which a central bank estimates and projects a particular and specific inflation rate. With the help of monetary tools and functioning of economic institutions the central bank then intends to bring necessary alterations in the interest rate being provided to meet the targets projected.
By implementing upon the policy of inflation targeting the central bank intends to introduce a more transparent method through which they can either lower or hike interest rates being offered by banks. A simple example that can be provided for explanation is that in cases when inflation in above the specified target, the bank is more likely to increase interest rates. This facilitates to introduce a cooling effect on the economy and helps in bringing down the level of inflation. Similar procedure is applied when inflation is below the set target.
Elements of inflation targeting
The policy of inflation targeting constitutes some fundamental elements that need to be adhered while implementing upon this policy. One of the core elements of the policy is that the mandate of inflation targeting which is also abbreviated as IT is held by the central bank. Secondly inflation targeting is considered explicit and unequivocal. Thirdly, the entire policy revolves around strict measures of transparency and accountability which is also one of the leading and pivotal measures of the central bank also.
In addition to this it is also among the salient features of the inflation targeting policy that subsequent and timely measures regarding the formulation of policies and economic approaches that can be helpful in the smooth functioning of the economic engine of the future as well as is considered logical and rationally applicable in terms of policy implementation. Last but not the least inflation targeting in considered a crucial step in order to facilitate the influx of investment opportunities in the country as the policies designed in conjunction with the features of inflation targeting favor investor choices.
Pros and cons of inflation targeting
There are various advantages that are affiliated with the phenomenon of inflation targeting. The first and foremost is that with the adoption of this financial policy many countries have been able to curb their long-run rates of hiking inflation and provide sufficient relief to their people. With the adherence of inflation targeting policy the authority and responsibility of the central authority and control of the central bank is also reinforced.
The very foundation of the inflation targeting policy accentuates upon the issue of incorporating transparency and restructuring of the financial institutions through which countries experience low rate of inflation in their societies. Moreover with the help of inflation policy there can be an increased level of anchoring that can be provided to the anticipations of inflation rise that can possibly occur. (Mishkin, 2001)
On the flip side there are also a couple of disadvantages that are related to the process of inflation targeting which include the restricted ability and potential of central banks to intervene and bailout other financial institutions in times of an economic meltdown, the lack of support that results from the non-interference of public and the prospective harmful repercussions that can emerge for the economy apart from inflation such as in terms of exchange rate, employment opportunities and other vital macroeconomic variables.