Inflation targeting neither
necessary, nor sufficient for price control: IMF Paper
Formal adoption of inflation
targeting (IT) is neither necessary nor sufficient for attaining low inflation
outcomes, a new IMF Working Paper has concluded.
There is also little
evidence that IT adoption improves macroeconomic performance, the Working Paper
revealed. This Working Paper authored by noted economists Surjit S Bhalla,
Karan Bhasin and Prakash Loungani has highlighted that for some countries, IT
leads to improved outcomes. However for most countries there is limited impact
of a formal targeting framework. This suggests that the experience of IT as
being a superior monetary policy framework is not as universal as it is often
claimed.
At a time when central
banks are struggling to keep inflation in check, the Working Paper results
suggest that the belief that IT adoption will be sufficient to achieve this goal
cannot be taken for granted. Put simply, IT is a technique used by Central
bankers to control the general rise in price level.
The Working Paper
examined the impact of formal adoption of IT on inflation, growth and anchoring
of inflation expectations in advanced economies and emerging markets and
developing economies (EMDEs).
The early adopters of IT
(pre-2000) all saw declines in inflation rates following adoption. However IT
adopters since then have enjoyed such success in only about half the cases, the
Paper revealed. IT adoption delivers significant inflation gains in about a
third of the cases. At the same time, the authors also found limited support
for the concern that adoption of IT systematically leads to poorer growth
outcomes.
This Working Paper titled
Macro-effects of formal adoption of Inflation Targeting comes at a time when
it is has become commonplace for central bankers and international financial
institutions (IFIs) to assert the benefits of the adoption on inflation
targeting.
While not denying these
claims, the authors, however, noted that Central bankers and IFIs would do well
to look at the evidence on IT with a more critical eye, given the dangers of
groupthink at these institutions as highlighted in some quarters .
For this study, the
authors looked into inflation performance of a total of 190 countries, of which
24 were classified as advanced economies (AEs) and the remainder as emerging
markets and developing economies (EMDEs). They used annual data on inflation
and GDP compiled by the World Bank and the IMF s International Financial
Statistics.
The Working Paper found
that though early IT-adopters ( pre 2000) saw inflation declines post adoption,
only half of the 22 subsequent adopters saw post-adoption inflation declines.
There is no difference
between IT-adopters and other countries in the average level and volatility of
inflation. Likewise, there is no difference in expected inflation and no
difference in the anchoring of inflation between the two groups, the Working
Paper concluded. Regression to the mean continues to offer a plausible
explanation for the assumed benefits of IT adoption, and we have shown that it
holds for EMDEs just as well as for advanced economies , it added.
A comprehensive
country-level analysis comparing inflation and growth outcomes in IT adopters
with a counterfactual turns up little evidence that IT adoption improves
macroeconomic performance, according to their findings.
The Working Paper has
suggested that the focus of central banks and IFIs ought to be on why some
countries had better outcomes than others, and what could be learned from their
experience that would be useful to other countries.
Noting that the results
of their study do not provide a full cost-benefit analysis of inflation targeting,
the authors have said there are several possible advantages to IT that have not
been considered here. At the same time, adherence to IT can also lead to
policy mistakes if policymakers become too focused on attaining the inflation
objective to the detriment of other objectives .
Alternative explanations
The authors have made a
case for serious consideration of the alternative explanations for the great
moderation in inflation. The main alternative explanation is that various
structural factors, such as demographic changes and globalisation have played a
key role in moderation of inflation over the last few decades, the authors
noted.
The Working Paper noted
that the decline in inflation over the last three decades coincided with the
formal adoption of inflation targeting. This makes it challenging to estimate
the causal impact of the adoption of inflation targeting on inflation. In
addition, theoretically, formal adoption of inflation targeting reduces
inflation by anchoring expectations and enhanced credibility of the central
bank. The same, could, in theory be achieved through a persistent period of low
inflation as experienced.
INDIA STORY
India had introduced
inflation targeting framework in 2016. Post this move, the concept of Monetary
Policy Committee (MPC) was introduced to set the policy rates in the country.
The inflation target
given to MPC for 2021-26 is 4 per cent with 2 percentage points on either side,
leading it to a tolerance band of 2-6 percent. This tolerance band is the same
as the one given for the previous five years beginning 2016.
RBI had in 2022 for the
first time failed to meet the contracted inflation target, triggering a letter
from the central bank to the government enumerating the reasons for the miss
and also when it sees the price rise coming to the 4 per cent mark.
India s average inflation
in three years prior to 2016 was 7.7 percent, while the average was 5 percent
in the next three years.
www.thehindubusinessline.com
dt. 24.01.2023