Transperency and inflation targets

Inflation targeting is a popular trend in modern banking. In early 2000s majority of central banks started to pursue a goal of greater transparency and inflation targeting was viewed as necessary tool for achieving it. However critics like M.Friedman stress a point that inflation targeting is deliberately making bank policies more obscure. I don’t believe this critique is entirely valid, yes practise of maintaining price stability could create some confusion, but with the help of the public situation can be improved.

In his paper on “Why the Federal Reserve Should Not Adopt Inflation Targeting” M.Friedman claims how central banks take one issue of inflation and put it at the center of all problems. This is a deliberate practise because it allows banks to do what they do and only talk about price stability. Okay that might be the case, but lets take a look at FED in 2004 , which at the time had no target and had to constantly look forward for possible threats to price stability in order to avoid time lags within monetary system. This practise did not require possible use of disinformation, instead it kept market participants totally in the dark guessing about the next policy move by the bank (this is so-called “just do it” approach). Both examples might seem flawed,but the difference is former could be improved  by the public involvment.

Bank communicates with other market agents by using multiple channels. Signals sent through these channels help to manage expectations within the market and avoid possible economic downturns. Bank can not reveal too much information about its strategies, because that could create confusing signals, that would lead to instability and finally lack of transparency, thus the idea is to simplify information, make it more approachable. Inflation targeting is the right tool for the job, summarising the whole financial strategy by using the desired percentage, but oversimplification attracts too much suspicion causes distrust and finally once again lack of transparency. Keeping those points in mind if central bank decides to use inflation targeting it must find a middle ground on how much information it should reveal, problem is it can’t decide that on its own.

In my view, inflation targeting should be understood as a frame allowing public to interpret economic activity if some measure moves out of this frame public has the right to demand the reason behind this change  that way banks are forced to consider releasing right amount of information. For instance, ECB uses flexible inflation target, during the recent recession deflationary pressure increased leading the public to ask for greater accountability, pushing ECB to finally publish its minutes and end the silence ( in 2015 ECB adopted this practise). Thus, ECB example shows that public in inflation targeting regimes has the power to determine the right amount of information

One question still remains what if public would become too concerned about monitoring inflation allowing bankers to put all their decisions under the inflation label (problem touched in the first paragraph)? That is improbability, like I mentioned inflation targeting frames  the economic activity, as S. Mishkin proved in his paper (replying to the same critique by M.Friedman) it affects other measures like output as well, thus it can’t use inflation to obscure other issues. For example central bank has to address negative output shock within the boundaries of inflation, if there is no other choice and interest rates have to be cut to the point of pushing inflation away from the target, public would demand a response why the change was made and whole issue would be explained.

To conclude, M. Friedman in his paper touched on the problem that too much focus on price stability can negatively effect transparency. I partly agree with this view because policy makers sometimes tend to oversimply matters and that could lead to the lack of proper information. However, public can address this problem, by analysing economic developments  through the frame of price stability and voice their concerns allowing the bank to measure the right amount of transparency


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