Why Central Bank Use Inflation Target? (2)

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A brief history of applying the inflation target

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New Zealand was the first country to pioneer inflation targeting in 1990. While the UK implemented inflation targeting in October 1992 after exit from the European Exchange Rate Mechanism.

The Bank of England Monetary Policy Committee (MPC) was given full responsibility in 1998 to set interest rates to meet the inflation target, the Government’s Retail Price Index (RPI) of 2.5%. The target changed to 2% in December 2003 when the Consumer Price Index (CPI) replaced the Retail Price Index as the UK Financial Inflation Index. If inflation exceeds the limit or decreases the target by more than 1%, the Governor of the Bank of England is required to write a letter to the Chancellor of the Exchequer explaining why, and how he will improve the situation. Targeting inflation then spread to other developed countries in the 1990s and began to spread to developing countries that began in the 2000s.

Although the ECB does not consider itself a central bank that implements inflation targets, following the start of the euro in January 1999, the European Central Bank’s (ECB) goal is to maintain price stability within the euro zone. The ECB Regulatory Council in October 1998 defined the price stability as inflation below 2%. Reflected in the phrase “Increase in Harmonized Data Index of Consumer Prices (HICP) year on year for the euro zone is below 2%” and added that price stability “should be maintained in the medium term”. The Regulatory Council confirmed this definition in May 2003 after conducting a thorough evaluation of the ECB’s monetary policy strategy. On that occasion, the Regulatory Council clarified that “in pursuit of price stability, it aims to keep the inflation rate below, but close to, 2% in the medium term”.

Since then, a 2% numerical target has become common for major developed countries, including the United States (since January 2012) and Japan (since January 2013).

A 2% figure seems to be a rational number for developed countries so that this value is adopted by many countries, although this figure is debatable.

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