KINGSTON — Inflation targeting, one of the critical strategies designed to enhance the Bank of Jamaica's (BOJ) primary objective of achieving price stability, is gathering momentum.
When fully implemented, this will serve to increase the accountability of the Central Bank, anchor inflation expectations and improve transparency in the bank’s conduct of monetary policy.
During a recent seminar targeting senior journalists, financial analysts and business commentators and staged by the BOJ’s Training Institute, Assistant Director, Research Services, BOJ, André Murray, explained that inflation targeting is a monetary policy strategy in which “the monetary authority assesses a desirable level of inflation and explicitly announces this level as its target”.
“The authority then utilises its policy tools, usually interest rates, to direct actual inflation to this target level,” Mr. Murray said.
“The BOJ’s conduct of monetary policy since 2000 has been consistent with inflation targeting. In particular, the announcement of inflation target at the start of each fiscal year. This target and path is assessed at the quarterly press briefing and included in the Outlook Chapter of the Quarterly Monetary Policy Report (QMPR),” he explained.
Simply put, inflation targetingis an economic policy in which a central bank estimates and makes public a projected or “target” inflation rate, and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.
Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting. For example, if inflation appears to be above the target, the bank is likely to raise interest rates. This can result, over time, in cooling the economy and bringing down inflation.
On the other hand, if inflation appears to be below the target, the bank is likely to lower interest rates. This usually can, over time, accelerate the economy and raise inflation.
Under the policy, investors know what the BOJ considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment decisions. This, ‘inflation targeters’ contend, should generate increased economic stability.
Mr. Murray pointed out that historically, monetary policy has sought to stabilise prices by targeting the fundamental factors that drive inflation. These include: the stock of money relative to the amount of real output; changes in the exchange rate (imported inflation) and the deviation of actual output from the country’s potential output.
“In most countries, central banks do not commit to an explicit policy, but reserve the discretion to change strategies as the need arises,” he said.
Inflation targeting differs from other monetary policy approaches in that the policy targets inflation directly and not intermediary variables, such as monetary aggregates and exchange rates. Importantly also, there is no ambiguity about the policy objective.
Mr. Murray said that the desirability of inflation targeting “serves to increase the accountability of the central bank; anchors inflation expectations; and improves transparency of monetary policy and in those countries that utilise this strategy, improved macro-economic prospects of higher growth and lower inflation”.
He noted that there may be some preconditions for the total application of inflation targeting. “Though desirable, some argue they are not required. They include: strong independence of the central bank; absence of, or low fiscal dominance in the domestic economy; and in addition, the central bank should have a thorough understanding of the monetary transmission process and the capacity to accurately forecast inflation,” Mr. Murray said.
He observed that the ease of adopting inflation targeting in Jamaica and the potential success, will depend on a number of macro-economic and institutional factors. However, a number of these issues have already or are currently being addressed.
“Jamaica has most of the ingredients for a relatively smooth transition to inflation targeting. The road ahead indicates a relatively stable macro-economic environment with inflation rates close to the desired target level. Fiscal consolidation and institutional reforms should reduce the amount of fiscal dominance in the economy. Discussions are underway to establish the autonomy of the Bank of Jamaica. Internally, the BOJ has significantly increased its capacity to implement inflation targeting,” he opined.
Meanwhile, the BOJ has also developed a suite of econometric models to enhance the inflation forecasting and the policy analysis processes and since the year 2000, the Bank started publishing the QMPR and has used it to sensitise the nation on key issues relevant to inflation targeting.
The strategy has been proven to effectively lower inflation, lower inflation expectations and improve growth prospects. It should be noted also that although some countries have missed their inflation targets at times, no country that has adopted inflation targeting has abandoned that strategy.
Among the countries that have implemented inflation targeting are the United Kingdom, Canada, Australia, Spain and Chile. Jamaica is well positioned to be the first regional bank to fully adopt this strategy.
By Allan Brooks