THE ARAB MONETARY FUND PUBLISHES A STUDY ENTITLED INFLATION TARGETING: ARAB AND INTERNATIONAL EXPERIENCES

by **claud39** Sun Feb 16, 2020 8:27 am

THE ARAB MONETARY FUND PUBLISHES A STUDY ENTITLED INFLATION TARGETING: ARAB AND INTERNATIONAL EXPERIENCES

2020-02-16

The Arab Monetary Fund publishes a study entitled

Targeting Inflation: Arab and International Experiences

40 countries (developed and developing) adopt the policy of targeting inflation as a nominal anchor of monetary policy

The inflation targeting framework enhances the independence of the central bank and the effectiveness of monetary policy

Successful targeting of inflation requires the development of sophisticated money and financial markets and the adoption of flexible exchange rate regimes and disciplined fiscal policies

It is difficult for policymakers to achieve the goals included in the inflation targeting strategy if they choose a narrow period of time to achieve these goals, and a limited range of inflation targets

A number of Arab central banks have resorted to adopting inflation targeting frameworks during the past two decades to achieve price stability

In the context of the efforts made by the Arab Monetary Fund in the field of research activities to support decision makers in Arab countries on priority issues, the Fund prepared a study on "Targeting Inflation: Arab and International Experiences" . The study highlighted a number of international and regional experiences targeting inflation. She also touched on defining the different frameworks of that strategy, the challenges facing policy makers when designing it, the results of studies that were concerned with measuring the efficiency of that strategy in improving economic performance, and the opinions of different economists regarding the advantages and disadvantages of the inflation targeting strategy, as the study presented in the last part a general evaluation of the policy Targeting inflation during the past three decades that have passed since its introduction, and the policy implications based on the experiences of developed and developing countries in implementing this policy.

The study showed that the strategy of targeting inflation or what is known as " Inflation Targeting ""It is one of the most prominent monetary policy developments since the 1990s that have received widespread attention from central banks worldwide. This strategy constitutes a commitment by the monetary authorities to achieve price stability and reduce inflation by adopting targeted rates The significance of this policy is to enhance the ability of monetary policy to support economic growth paths by maintaining price stability. Through this policy, the central bank controls the paths of inflation through the use of indirect monetary policy tools Suha interest rate tool to keep inflation within the target that limits based on the inverse relationship between inflation and interest rates, which leads to increased levels of economic stability, according to supporters of this policy.

The study indicated that the first application of the Fully Fledged Inflation Targeting Framework was made in New Zealand in 1990, followed by its adoption in Canada and Britain in 1991 and 1992. Since that time, many central banks are keen to implement it until the number of countries that follow that framework since that time until 2019 reached about 40 countries, and these countries vary between advanced industrial countries and other emerging or developing countries [1] . However, on the other hand, some studies indicate that the number of countries that have a specific goal to target inflation, whether totally or partially, is 67 countries worldwide in 2018, including 20 countries that adopt achieving low inflation targets ranging from 2 to 2.5 per cent [2] .

Economic studies attribute three quarters of the economic development that characterized the nineties of the last century, represented by the decline in inflation levels, the increase in global economic growth rates to the improvement of monetary policies during that period and the tendency of a number of central banks worldwide to adopt a strategy to target inflation as a primary axis of focus Monetary policy, while the remaining quarter attributes to the stability of the global economic environment [3] .

The result of this strategy was the decrease in the rate of inflation in the United States of America, the largest global economy, from 6 percent at the beginning of the decade of the 1980s to 2 percent at the end of the 1990s, while that strategy also helped to increase the rate of growth of the American economy from less than 3 in The cent in the beginning of the nineties to more than 4 per cent by the end of that decade, and helped to decrease fluctuations in levels of output and inflation significantly in a number of developed countries after the trend of central banks to implement that strategy [4] .

Other studies also show that the strategy to target inflation has helped many emerging countries overcome their economic crises of high levels of inflation to acute levels exceeding 20 percent, and indicate that this framework not only succeeded in reducing inflation, but also succeeded in achieving more stability in Inflation levels during the period in which developing countries followed this framework, and indicated that targeting inflation enabled policymakers to better control unforeseen inflation shocks and make their time range relatively shorter compared to countries that did not follow that framework.

But in contrast, other studies have suggested that the economic improvement resulting from adopting this framework can not only be attributed to the strategy of targeting inflation, but is also linked to other economic reform policies. In addition, studies indicate that an inflation targeting strategy may not pay off in the event the central bank is unable to control price rates despite its adoption of this policy, which may lead to influence confidence in monetary policy.

In addition to the above, and in light of the developments that resulted from the global financial crisis that confirmed the importance of the central banks ’focus on achieving the goal of financial stability along with the goal of price stability, calls for adopting a policy of what is known as Integrated Inflation Targeting , a policy whereby coordination and integration between all of the monetary policy instruments, and policy tools precautionary College ( Macroprudential policy app ) in achieving the goals of price and financial stability together, manage aggregate demand more efficiently.

The study touched on the experiences of some developed and developing countries in targeting inflation and pointed to the tendency of four Arab countries represented in Egypt, Tunisia, Algeria and Morocco to adopt a policy of targeting inflation with a view to achieving price stability and ensuring that inflation rates move in levels that support economic growth, and showed the success of the policy of targeting inflation in Egypt following the implementation of the economic reform program that was implemented during the period (2016-2019) and which helped to increase levels of exchange rate flexibility and enabled the adoption of disciplined financial policies.

In light of what was discussed in the study, some conclusions and repercussions have been made on the policy level regarding the inflation targeting policy, as follows:

The successful implementation of the inflation targeting policy contributes to controlling inflation and reducing the cost of combating inflation to levels that do not harm the social welfare function, within a framework that allows at the same time to monitor developments in the exchange rate, and to address the various shocks to which the economy is exposed and overcome without raising inflation levels or compromising levels of price stability .
The inflation targeting framework contributes to supporting levels of macroeconomic performance through its role in significantly reducing fluctuations in levels of output and inflation, as well as better control of unexpected inflation shocks and making their time range relatively shorter.
The adoption of the Full-Fledged Inflation Targeting Framework requires the central bank’s commitment explicitly to meet a specific inflation rate, or its commitment to move the inflation rate within certain limits during a specific time period, periodic announcement of inflation targets to the public, and institutional arrangements to ensure the central bank’s accountability for Achieve this goal.
Most countries favor targeting a single low digit inflation target, as is the case in a number of developed countries such as the United States of America, the European Union, and Japan, where an inflation rate of about two percent is targeted.
Central banks usually focus on achieving inflation targets in the medium term - over two to three years - which gives the central bank the ability to adopt tools that help it achieve other monetary policy goals with the discretionary power of the central bank to respond to short-term shocks, thus the bank becomes The Central does not have to do everything necessary to achieve the goals on a case-by-case basis.
It is often difficult for monetary policy makers to achieve the goals included in the inflation targeting strategy if they choose a narrow period of time to reach those goals and choose a limited range for inflationary goals. Narrow inflationary targets usually create two main challenges: difficulty in controlling inflation levels in the specified time frame, and the failure to use appropriate monetary policy tools in light of the central bank’s fear of the possibility of not realizing the target set in time. Therefore, it would be better for policymakers to include in the inflation targeting model some possible paths of failure to reach the target, or what is known as escape clauses , according to some expected and unexpected economic assumptions. In addition to the targeting of "core inflation" ( Core Inflation ) rather than inflation targeting total ( Headline Inflation), Extending the time range of the inflation targets, in addition to setting inflation targets for several consecutive years and not a specific goal for one stage of time.
The success of the inflation targeting policy requires the presence of developed monetary and financial markets in order to pass the monetary policy directions to the real sector. The adoption of this policy requires the development of monetary policy tools and the efficiency of monetary policy transmission mechanisms .
The inflation targeting framework enhances the independence of the central bank and the independence of monetary policy, as countries whose central banks enjoy greater independence achieve success in implementing the frameworks targeting inflation targets. Sometimes the inflation targeting strategy requires the central bank to have declared independence in achieving the goals and implementing the relevant monetary policies.
The gradual implementation of this framework deepens the levels of credibility of the central bank by emphasizing the importance of periodic communication between the central bank and economic actors to achieve one goal that concerns the entire community and the creation of effective communication channels, unlike other models of monetary policy that may not require the availability of that much interaction between the bank Central and economic actors.
Inflation targeting frameworks that deal with very high levels of inflation face many challenges for policymakers, and it is difficult to set and announce annual levels and goals of inflation that can be achieved in light of the high rates of inflation expected, and declining levels of confidence in policies, unlike the inflation targeting frameworks that resort Mostly, countries with low levels of inflation are aimed at converting to more stable levels of inflation.
Many central banks use the consumer price index that does not include food and energy prices that are rapidly affected by supply shocks or what is known as Core Inflation , as a basis for targeting inflation, which enables the central bank to accurately determine the components of inflation that the central bank is able to influence. Through its monetary policy, the most prominent of which is the component driven inflation ( Demand pull inflation ).
Changes in exchange rates greatly affect the inflation targeting frameworks pursued by the Central Bank, especially in cases of relatively small economies open to the outside world. This places more burdens on the central bank's policymakers, and may prevent the implementation of inflation targeting frameworks successfully if appropriate mechanisms are not available to relieve pressure on the foreign exchange market.

The full version of the study is available at this link

https://www.amf.org.ae/ar/economic-studies/tiaie-160220

[1]    Jahan S., “Inflation Targeting: Holding the Line Central banks use interest rates to steer price increases toward a publicly announced goal”, IMF, F&D Magazine.
[2]    Fisher, P. (2019). “Why do most central banks target inflation?”, The University of Warwick, May.
[3]    Cecchetti, Stephen G., et al. (2013). “Has Monetary Policy Become More Efficient?” unpublished manuscript, May.
[4]    Cecchetti S, G, and Kim J, (2003). “Inflation Targeting, Price-Path Targeting and Output Variability”, Working Paper 9672, http://www.nber.org/papers/w9672

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