Inflation is an increase in the prices of goods and services in the economy. It is linked to a variety of other economic factors and phenomena, both as a cause and result of inflation. These factors can be quite varied and can result in both negative and positive impacts on the economy.
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Governments, usually through their central bank, have various methods to identify and reduce inflation. However, the response is invariably political in nature, primarily because the efforts to lower inflation can sometimes result in a lack of attention to issues such as unemployment.
Additionally, inflation does not target all industries equally. Special attention to inflation made on the part of banks and government entities may insufficiently lower process in one industry, or ignore another sector. Due to the globalized nature of the economy, allowing inflation to continue unchecked can have disastrous consequences, not only to the nation it originates in, but also in nations it is trading with.
Prime example of inflation and poor economic or political responses and its effect throughout the world, is from the most recent recession of 2007-2009. Also known as the Great Recession which is one of the biggest financial crises since the Great Depression of the 1930’s.
What is the principal premise behind inflation targeting?
Inflation targeting is an economic policy where authorities set a monetary goal and shape the policy to match it through the use of interest rates and other budgetary tools. These figures are what dictate the prices of products within the country. Using this form of policy is a secure method in regulating the costs of conducting business.
In other words, the amounts paid out in labor and production remains lower than the value received. In theory inflation targeting is straightforward: the impending rate of inflation is predicted by the central bank, later on it is juxtaposed with the target rates which the government considers as appropriate for the economy and intends to achieve.
The difference between the predicted amount and the goal determines how much monetary policy has to be adjusted (Mishkin, 2001). This type of financial manipulation is meant to avoid a shortage of available goods, as well as to encourage public investing and savings into capital funds such as stocks and bonds in order to maintain the overall money supply.
What evidence indicates that managing the money supply is the principal task of inflation targeting?
Inflation targeting is a method used by the Central Banks in order to control the economy as well as maintain stability in the financial markets. This means the Bank is responsible for keeping a balance between the supply and demand for money.
Taking into account that numerous transactions use currency, there is a significant influence of money on economy of the country. In order to increase the supply of available funds, Banks will reduce interest rates, which encourage investments and also give more buying power to the consumer.
An increased sale on goods persuades corporations to order more materials and increase production. The expansion of business performance requires more employees and influences on the demand for capital goods. The prices are raised with the influence of the situation caused on the stock market in a supple economy.
This in its turn forces companies to deal with debts and equity. If the money supply continues to expand, prices begin to rise and banks will then raise interests’ rates in order to offset the inflation rate. However, if left un-monitored or in the case of the recent recession, reducing interest rates too low will have a disastrous impact on the economy.
Some experts believe this was the main cause of the current downturn; loose lending on the part of the Banks coupled with no-money down loans provoked a rapid rise in the housing market. When this same market crashed, a majority of the loans went into default and with no capital to collect on; Banks were facing real dangers of bankruptcy.
Is there an ideal rate of Inflation?
Ideally inflation rates should be stable at 2 percent per year allowing room for economic growth. Amounts which are over 3 percent or below 1 percent are generally a cause for concern. The United States for example, has experienced low levels of inflation recently due to the sluggish economy following the Great Recession.
Currently the inflation rate is about 2.5 percent of the gross domestic product which is up from the negative 1.3 percent during the recent economic decline (Losman, 2010 & Luojia & Toussaint-Comeau, 2010).
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Have monetary policy makers embraced policy initiatives through extensive understanding of these relationships? What does evidence show?
After the recent economical crisis, emergency interventions were implemented in order to rescue many national financial systems. Stimulus plans and major bailouts became a major factor in financial policies. In the United States the “ARRA (The American Recovery and Reinvestment Act of 2009)” (Isidore, 2009), was created in order to take immediate action against the growing crisis.
Its primary objectives include: job creation, investment in infrastructure, education, health and capitalize on the green movement. The estimated cost of the recovery program is over $700 billion (Isidore, 2009) The main principal behind the ARRA is that “…during recessions governments should offset the decrease in private spending in order to save jobs and stop further economic deterioration” (Isidore, 2009).
Despite official statements made by government officials about recent economical stability, the general population remains pessimistic. Falling income, rising unemployment and an increase in energy and food costs, have critics believing the country is still in crisis and possibly facing another recession.
Isidore, Chris. “The Great Recession”. CNNMoney. March 2009. Web. July 2012.
Losman, Danakan.. (2010). “The Rise of Stealth Inflation”. Challenge, 2010. Questia Trusted Online research. Web. July 2012.
Luojia, Hu, & Maude Toussaint-Comeau. “Do Labour market activities help predict inflation?” Economic Perspectives. Questia Trusted Online research. 2010. Web. July 2012.
Mishkin, Frederic S. “Inflation Targeting”. National Bureau of Economic Research. July 2001. Web. July 2012.