How Inflation Targeting Operates in the UK - Coursework Example

Inflation Targeting Inflation Targeting This paper discuses inflation targeting, as a monetary policy mechanism that hasbeen adopted and extensively applied in several countries in the past two decades. The discussion will be centered on the application of inflation targeting in UK more particularly how it affects the conception and practice of monetary policy. Under normal circumstances, inflation is a major parameter in monetary policy along with overall economic management. As a result, the progress or temper of the economy is determined to a great extent by the level of inflation prevailing in the economy. Hence, managing inflation has become a major function of several players in the economy and government. Inflation targeting offers a new formula for inflation management and overall formulation and application of monetary policy. The traditional mechanism involved the public declaration of inflation figures for the subsequent year. However, this has proved to be inefficient as it fails to provide the way forward towards maintaining a stable inflation rate for economic viability. Inflation targeting has been applied in the UK since 1992 with several modifications and advancements made over the years with exceptional reference to 1997. Comparative statistics indicate that there has been great improvement as regards stability of inflation rate as well as the development and application of viable monetary policy mechanism tact since the launching of inflation targeting in UK two decades ago. This is an indicator of the numerous benefits of inflation targeting as an effective mechanism of managing inflation and monetary policy. This paper will specifically focus on the practice of inflation targeting in UK as well as its relevant benefits (Benati n.d, 4). Historically, the monetary strategy of UK has been in a condition of continuous upheaval in the period following the Second World War. Nevertheless, from the state of affairs of several nations there are a number of frameworks in addition to monetary strategy that brought about a certain level of macroeconomic stability in UK which could not have been considered in 1992 (Bean 2003, 26). There are two important ingredients namely inflation target and operational independence, the most significant is the inflation target. There has also been the aspect of reinforcing stable and low inflation along with affixing inflation expectations. A number of challenges will emanate and threat monetary strategy makers in UK as well as other parts of the world. The application of inflation targets in UK will require evolving significantly in order to overcome the challenges. At this moment more needs to be done though currently the structures provide a strong and dynamic device to deal with challenges. Inflation targeting is a monetary policy mechanism that involves a number of parameters like the open declaration of medium term statistical targets for inflation, obligation to price stability as a main objective, high intensity information practice where variety of parameters are applied in developing policy devices, openness in monetary policy strategy via avenues of communication as well as a high degree of accountability on the part of central bank regarding inflation. In broad sense, inflation targeting implies the practice that goes beyond the traditional declaration of statistical figures of inflation for the coming period. Inflation targeting is a good mechanism particularly for emerging countries owing to the fact that most of them regularly announced statistical figures as a central pillar of economic planning. Inflation targeting has been extensively adopted as a policy mechanisms since the early 1990’s by both industrialized like Israel and UK and upcoming countries like Chile and Brazil (Bernanke 2003, 1). Basically, inflation targeting involves making a decision regarding the meaning of price stability in application. A credible connotation of price stability is the degree of inflation which is quite low to the extent that businesses and domestic users need not factor it in the routine choices. Therefore, an inflation rate of 0%-3% is reasonable and represents price stability. However, there are several other opinions on which degree of inflation is reasonable or symbolizes price stability but majority of the contributors’ state that 3% inflation is reasonable. Among the contentions provide by a number scholars revolve around the effects of low or high inflation. For instance, low inflation is associated with inefficiency which creates an escalating spate of unemployment. On the other hand, exceedingly high inflation is an incubator of financial instability that is not good for the economy (Lambert, n.d, 14). Among the many momentous developments as regards central banking in recent decades involves the implementation of inflation targeting. The mechanisms slowly developed from the previous tactics that came after the end of Bretton-woods system of fixed exchange. German was a pioneer in the application of inflation targeting by conducting targets of money and supply growth. However, the major development of inflation targeting involves Bundesbank’s preference of inflation targets over growth targets in making financial decisions. Therefore, inflation targeting was evolved as an alternative monetary policy regime to replace the traditional approaches that had become ineffective in offering outcomes. Owing to the huge importance of inflation in economic management and the very aspect of inflation management, it became necessary to devise a more effective approach that could be reliable in offering direction towards the establishment of a stable level of inflation (Epstein 2010, 18). Towards the beginning of the 1990’s inflation targeting became very popular with several countries adopting it in the routine monetary and inflation policies. Among these many industrialized and upcoming countries was UK, the bank of England embraced inflation targeting as a method of approaching monetary policy and inflation management. This was just the beginning of a long strategy that was to overwhelmingly alter monetary and economic management in the industrialized nation. To underscore the success of this mechanism, the many countries that adopted inflation targeting along with UK in the 1990’s have not deviated from its practice. As a result, inflation targeting has been in practice for the last twenty years not just in UK but also in many other countries. This indicates the effectiveness of inflation targeting as a mechanism of addressing the aspect of inflation in specific areas as well as economy in general (King 2005, 19). The UK adopted inflation targeting in 1992 but the regime was developed subsequently, among the vital developments of inflation targeting was the 1997 where the operational obligation for monetary strategy was entrusted to the bank of England a long with the institutional arrangement associated with it. The adoption of inflation targeting in 1992 immediately had a significant effect on the formulation and practice of policy. Quite a number of literatures have been published on the wider aspect of inflation targeting particularly how it was adopted and subsequently changed and applied in the United Kingdom (Tucker n.d, 10). When discussing inflation targeting in the United Kingdom it is important to focus on the independence of the bank of England. This is because of the undeniable fact that the success of monetary policy formulation and application is directly related to the independence of the bank from other organs of the government. Under normal circumstances the failure of monetary policy stems from the lack of institutional independence of the central bank. In conducting target inflation and managing the economy, the central bank requires independence in order to prevent government interference. A review of the performance of the bank of England coincides with the aspect of independence in the sense that there is a great indication of improved performance of the bank since it obtained independence. There has been significant improvement in the bank’s performance as regard monetary policy management ever since it became independent. This is enough proof that the lack of independence of central banks is a huge impediment towards the achievement of effectiveness. UK followed the trend started by the Reserve Bank of New Zealand in practicing inflation targeting. The results have been astounding as inflation has been stable and low particularly in the perspective of previous rates in the country. Therefore, inflation targeting has been phenomenally successful in United Kingdom as a method of developing and applying monetary policy. From this point of view, it is necessary to note that inflation targeting has numerous benefits and with special reference to the UK it is obvious that inflation targeting has been very beneficial. One of the benefits as noted is the exceptionally steady and low inflation rate, which has been good for the vast economy of the country (Truman 2003, 45). Under normal circumstances the main aim of a monetary policy is to achieve a lower and stable inflation rate, which not only permits economic activity but also sustains it without negatively affecting life and business. Therefore, effectively maintaining lower inflation rate is a huge advantage of inflation targeting. A subsequent benefit of inflation targeting in UK is the fact that the achievements of the policy framework have not been realized at the expense of any crucial parameter in the economy. As a result, other parameters in the economy remain steady implying that inflation targeting has a comprehensively positive effect that does not bring about inequalities. A clear indicator of this is the steadiness of growth which has remained consistent since the inception of the policy framework. Another indicator is the rate of unemployment, which has consistently dropped in the course of the last ten years. In fact, the low rates of unemployment can only be compared to the rates witnessed in the 1970’s. What has been witnessed in the UK for the last two decades when inflation targeting was incepted has astounded many experts who could not have expected the economy to perform so well. All these point towards the success, effectiveness and benefits of inflation targeting in the United Kingdom. It is therefore obvious that inflation targeting has been doing well in the UK (Mishkin 2001, 5). Inflation targeting has been in practice in UK for the last two decades and its success has been unprecedented in the history of the country’s central banking. The success of inflation targeting in UK lies in the fact that ever since it was adopted inflation has remained stable and that there has been no need to alter it to another system. Additionally, several countries that adopted inflation targeting at the time when UK adopted the system have maintained it implying that inflation targeting is effective in achieving inflation goals along with other monetary objectives. The bank of England adopted inflation targeting in 1992 together with other developed and developing countries. This was aimed at introducing a more effective inflation and monetary policy regime that will lead towards better inflation stability. This is highly associated with economic viability and employment. Inflation targeting involves the identification of a stable inflation also regarded as stable price rates. The rates of prices determine economic activity and drive the economy in general (Mishkini et al 2001, 54). Therefore, a stable price rate is good for the economy as it permits growth and survival without much inconvenience. Statistics indicates momentous improvement in inflation management in UK after the adoption of inflation targeting. In essence, inflation targeting involves two sections a strategy framework of controlled tact and a communication approach to concentrate expectations as well as elucidate the strategy system to the masses. The two attributes advance price stability along with better inflation expectations. As a result, a carefully developed and suitably applied inflation targeting policy can bring about excellent outcomes as regards inflation, output and employment. In as much as communication is a significant parameter in inflation targeting, conceivably the most significant facet is concentrating and affixing expectations. Obviously, mere talking achieves very little because policy matter require concrete action. Additionally, for a flourishing and plausible central bank like the bank of England reliable communication plays an important role in articulating the bank’s policies. However, investing more in openness, economic assessments, objectives, plans and higher dividends could bring better results than mere communication. Reference List Bean, C. 2003, Inflation targeting: the UK experience. Retrieved from http://www.bankofengland.co.uk/publications/Documents/speeches/2003/speech2 03.pdf Benati, L. n d, The inflation-targeting framework from an historical Perspective. Retrieved from http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb050 203.pdf Bernanke, B. 2003, A Perspective on Inflation Targeting. Retrieved from http://www.federalreserve.gov/boarddocs/speeches/2003/20030325/ Epstein, G. 2010, Alternatives to Inflation Targeting: Central Bank Policy for Employment Creation, Poverty Reduction and Sustainable Growth. Edward Edgar Publishing, Washington. King, M. 2005, Governor of the Bank of England Monetary Policy: Practice Ahead of Theory Mais Lecture 2005, accessed 22nd November, 2012 fromhttp://www.bankofengland.co.uk/publications/Documents/speeches/2005/speech245.pdf Lambert, R. n.d, Inside the MPC, accessed 22nd November, 2012 from http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb050 105.pdf Mishkin, F. 2001, Inflation Targeting, accessed 22nd November, 2012 from http://www0.gsb.columbia.edu/faculty/fmishkin/PDFpapers/01ENCYC.pdf#searc h=%27mishkin%20inflation%20targeting Mishkini et al. 2001, Inflation Targeting: Lessons from the International Experience. Princeton University Press, Princeton. Truman, E. 2003, Inflation Targeting: In the World Economy. Institute for International Economic, London. Tucker, P. n.d, Reflections on Operating Inflation Targeting, accessed 22nd November, 2012 from http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb060209.pdf Read More