What is inflation targeting?
Technically, inflation targeting is a type of monetary policy framework. A Monetary Policy Framework shows how a central bank’s policy instrument (like repo) works in the economy to influence (hit) a target (like inflation). The main features of inflation targeting framework are:
- Single target: inflation
- Single instrument used by the central bank: short term interest rate (repo)
- Single objective: Price Stability.
Why inflation targeting is controversial?
A unique and at the same time a controversial feature inflation targeting is that the central bank should sideline all other objectives to ensure that the single goal of price stability is realized. This strategy makes the IT framework generally unacceptable in the developing world. This is because there are two problems while a developing country central bank adopt it.
First, fighting inflation or price stability is one important objective of the general macroeconomic objective in fast growing developing economies. The equally important objective is achievement faster economic growth. Second one is that generally there is conflict or trade-off between the objective of price stability and economic growth. Another limitation of inflation targeting in countries like India, it neglects the real cause of inflation – agricultural supply shocks which can’t be solved by any monetary policy action.