Thursday, February 24, 2011

What inflation target to set

Central banks, implicitly or explicitly, set targets for the inflation rate, usually in the form of an interval. What determines this interval and its mid-point? Theory tells you that larger economic fluctuations should leads to wider intervals and less central bank independence should like to higher targets.

Roman Horváth and Jakub Matějů set out to verify this by way of questionnaires to central bankers and sifting through official publications. They gather data from 19 countries, including how the targets have changed through history and confirm the conjectures above. They also find that targets seem to accommodate inflation expectations and follow world inflation. Interestingly, the party in power does not matter, even for less independent central banks. But one aspect that is not covered and I have always wondered about is how the dominant dogma would matter. Indeed, if a central bank believes in activist policy, it would presumably allow for a wider target interval. Or a neo-classical central banker would want a very low target inflation.

1 comment:

Jesse said...

I don't think it's important to set inflation goals, especially when you have a system where the CPI formula is being tweaked to exclude the variables that affect the cost of living in order to showcase that official inflation is low and meet the set standard and goal.