Inflation Targeting as a Strategy of the Conduct of Monetary Policy

INTRODUCTION

Inflation targeting is a strategy of monetary policy that is used to achieve goals. This paper is going in a short way to describe monetary policy, The criteria for choosing targets, Bank of Canada experience with monetary policy, Strategies for conduct of monetary policy, exchange-rate targeting, monetary targeting, implicit nominal anchor, inflation targeting, and experiences with inflation targeting.

What is Monetary Policy?

Monetary policy is one of the tools that a national Government uses to influence its economy. Using its monetary authority to control the supply and availability of money, a government attempts to influence the overall level of economic activity in line with its political objectives. The goals of monetary policy are "macroeconomic stability”: low unemployment, low inflation, economic growth, and a balance of external payments. Monetary policy is usually administered by a Government appointed "Central Bank", the Bank of Canada. (1) In addition, Monetary Policy involves changes in the base rate of interest to influence the rate of growth of aggregate demand, the money supply and ultimately price inflation.

There are two kinds of monetary polices, Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy and is used to combat unemployment in a recession by lowering interest rates and a contractionary policy decreases the total money supply and has the goal of raising interest rates to combat inflation.

Monetary policy, however, has certain weakness. Unlike fiscal policy which can be focused on particular regions or aggregate markets, monetary policy has a broad impact on all parts, regions or markets of the economy. Economists usually distinguish between recognition, decision and impact lags. In addition, the effectiveness with which both instruments are used to attain objectives depends crucially on the institutional structure of the economy.(2)

Moreover, the benefits of monetary policy are defined to maintain low, stable and predictable inflation is the best contribution that monetary policy can make to a productive, well-functioning economy. It allows to businesses people to make spending and investment decisions with more confidence. (3)

“Common to all frameworks for understanding the role of monetary policy in the economy is the need to distinguish between Structural model evidence and reduced form evidence”. Also we know that in the first period, market participants make irreversible economic decisions based only on expectations about the future stance of central bank monetary or government fiscal policy. Policy makers act in the second period, although they may announce future policy intentions during the initial period. As a result, policy signals may not be accepted at face value. Sometimes the central banks cannot directly manipulate a particular goal and consequently uses strategies to influence or reach its goal.

Criteria for choosing targets

Criteria for choosing targets: 1)Measurability 2)Controllability 3) Ability to predictably affect goals. Interest rates aren’t clearly better than Ms on criteria 1 and 2 because hard to measure and control real interest rates. Criteria for operating targets: 1)Measurability 2)Controllability 3) Ability to predictably affect goals. Reserves aggregates and interest rates about equal on criteria 1 and 2. For 3, if intermediate target is Ms, the reserve aggregate is better

Bank of Canada experience with monetary policy

In this behaviour and operation of monetary policy, the Bank of Canada adopts several “tactics” and “strategies” to make sure that its monetary policy actions are transparent to financial markets. Even though economic theory suggests that this is done to reduce indecision, it can be further that the Bank does this to improve its credibility to permit market participants to comprehend not only its views on the economy but also the inflation viewpoint that underlies its policy stances. It is now usually accepted that the Bank of Canada conducts monetary policy by influencing short-term interest rates through changes in the target for the OVERNIGHT RATE OF INTEREST. Presently, the Bank sets a target for this key interest rate. Policy changes in the overnight rate affect other interest rates such as those for consumer loans and mortgages. They can also affect the exchange rate of the Canadian