Why target inflation?

INFLATION TARGETING is based on the premise that stable prices contribute to stable output over the medium to long term.

Inflation targeting is based on the government’s aspirations to achieve a symmetric progression in output, so therefore, fluctuations above a specific inflation target is equally as bad as fluctuations below the inflation target, as it is price stability that will maintain output stability.

Inflation targeting is a medium-term phenomenon, so fluctuations in the short term are irrelevant. It makes no sense justifying quarterly or monthly deviations; the inflation target is for at least a one-year period.

Inflation targeting is based on core inflation, so it normally omits consumer items whose prices change easily.

It enables domestic monetary policy to respond flexibly to domestic shocks.

Inflation supposedly reduces politicising of monetary policy. Disadvantages of inflation targeting:

Many economists have found evidence to suggest that inflation targeting might not be the correct strategy for developing and emerging market economies. According to Mishkin (2001): Inflation targeting might be too rigid.

It allows too much discretion.

It has the potential to increase output instability.

It has the potential to lower economic growth.

These, Mishkin (1999) and Bernanke, et al (1999), outline are not so detrimental if the country’s inflationtargeting instrument is properly designed. But the following can be dangerous for emerging market economies:

Inflation targeting weakens the accountability of the central bank because inflation is a real-life occurrence that is hard to control, and because there are long lags from the monetary policy instruments to the inflation outcome; this is an especially serious problem for emerging market countries.

Inflation targeting might correspond to extreme exchange-rate flexibility that might cause financial instability.

Davis and Fujiwara (2015) have found evidence to suggest that inflation targeting works best in small, closed economy that does not participate much in international trade. For small, open economies who participate immensely in international trade, the overall welfare of the country increases if the central bank targets the nominal exchange rate.