Why Central Bank Use Inflation Target? (1)

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Inflation targeting is a monetary policy regime in which the central bank has a clear inflation target for the medium term and announces this inflation target to the public. Using the assumption that the best monetary policy is a policy undertaken to support long-term economic growth. The trick is to maintain price stability. The central bank uses interest rates as its main short-term monetary instrument.

With inflation targeting, the central bank will raise or lower interest rates on the basis of whether inflation is above the target or below a predetermined target. Conventional monetary policy is that the central bank will raise interest rates to cool the economy by controlling the rate of inflation; While the central bank will lower interest rates to accelerate the pace of the economy to encourage inflation.

There are the first three countries to implement the full inflation target of New Zealand, Canada and the UK in the early 1990s. And Germany has adopted many factors from the inflation target.

A brief history of applying the inflation target

The initial proposal or idea of ​​the monetary system is more inclined to target price levels or inflation rates rather than exchange rates, after the gold standard crisis after World War I. Irving Fisher proposes a “dollar compensation” system in which the gold content in paper money will vary with the price of goods valued with gold, so the price level in terms of paper money will remain intact. Fisher’s proposal was the first attempt to target prices while retaining the gold standard automatic function.

In his book Tract on Monetary Reform (1923), John Maynard Keynes advocated what we now call the inflation target scheme. In the context of sudden inflation and deflation in the international economy after World War I, Keynes recommended a policy of exchange rate flexibility, valued the currency in response to international inflation and depreciated it when there was international deflationary power, so that internal prices remained more or less stable. Interest in the inflation target faded during the Bretton Woods era (1944-1971), as it did not correspond to the currency exchange rate that prevailed for three decades after World War II.

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