Description
Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools
G-24
Policy Brief No. 14
Inflation Targeting, Employment Creation and Economic Development
Gerald Epstein and A. Erinc Yeldan
Inflation targeting has become the dominant monetary policy prescription for developing and industrialized countries alike. Initially adopted by New Zealand in 1990, the norms surrounding the inflation targeting regime have been so powerful that virtually all Central Banks have declared that maintaining price stability with inflation in the “low single digits” is their only mandate. It is further maintained that price stability will lead to sustained growth and employment creation. The inflation targeting policy framework involves “the public announcement of inflation targets, coupled with a credible and accountable commitment on the part of government policy authorities to the achievement of these targets”, i with the target usually in the “low single digits.” In addition, inflation targeting is often associated with changes in the central bank law that enhances the independence of the institution. In practice, while few central banks reach the “ideal” of being “full fledged” inflation-targeting institutions, many nonetheless focus on fighting inflation to the virtual exclusion of other goals. Ironically, employment creation has dropped off the immediate agenda of most central banks just as the problems of global unemployment, underemployment and poverty are taking center stage. The ILO estimates that in 2003, approximately 186 million people were jobless, the highest level ever recorded. ii Moreover, the ILO estimates that 22% of the developing world’s workers earn less than $1 a day and 1.4 billion (or 57% of the developing world’s workers) earn less than $2 a day. To reach the Millennium Development Goal of halving the share of working poor by 2015, the ILO’s evaluation shows that on average, real GDP growth has to be maintained at 4.7% per year to reduce the share of “$1 a-day-poverty” by half, and significantly more than that to halve the share of “$2 aday-poverty.” The key problem is that ongoing financial globalization appears primarily to redistribute limited jobs across countries, rather than to accelerate capital accumulation and job creation across the globe. Currently, global growth is highly uneven and geographically too concentrated to generate sufficient jobs world-wide and, moreover, is associated with too little fixed capital formation. Under these conditions, price stability, on its own, will not suffice to maintain true macroeconomic stability, because, it will not secure financial stability and employment growth. As the sub-prime financial crisis originating in the U.S. forcefully exemplifies, it is financial rather than price stability that threatens overall macroeconomic performance. Against this background, the main motivation of the research summarized here is the conviction that modern central banks ought to move beyond a focus solely on low inflation. Instead, central banks—as most did for decades following the Second World War—should strike a balance among various objectives, with employment creation and more rapid economic growth joining inflation and stabilization as possible goals, depending on the circumstances and challenges facing each country. Equally important, to carry out this broader mandate, central banks must have the opportunity to utilize sufficient tools to achieve more objectives. In the following pages, we will summarize the findings of a series of country studies on alternatives to inflation targeting undertaken by a team of researchers organized by PERI (Political Economy Research Institute at the University of Massachusetts, Amherst) and Bilkent University. iii The country studies, produced by a team of country experts, assess the macroeconomic performance of currently existing inflation targeting frameworks, and, more importantly, develop alternative monetary policy frameworks that could better achieve important social and economic goals—all within specific country contexts, including Argentina, Brazil, India, Mexico, The Philippines, Vietnam, South Africa and Turkey. In addition, the project includes several thematic studies relevant to the issue of monetary policy and inflation, including differential gender impacts of contractionary monetary policy, and the impacts of inflation versus economic growth on different income groups within countries. Reporting on the results of this research project, we outline why a shift away from inflation targeting and towards a more balanced approach is both feasible and desirable. Furthermore, to contribute to the task of designing a more socially desirable macroeconomic policy environment, we offer viable alternatives to inflation targeting in order to promote employment, sustained growth, and improved income distribution. Macroeconomic record of inflation targeting Much of the existing literature on the record of inflation targeting has focused on whether inflation and its volatility have been reduced, and whether other objectives, in particular the volatility of output, have been compromised. With respect to the issue of inflation levels,
____________________________________________________________________________________________________ G-24 Policy Brief No. 14 1
a key question is whether inflation has come down in negative costs of inflation on output and employment, response to adoption of the framework itself or due to a there should be some direct survey evidence indicating set of “exogenously welcome” factors. On the one side, people’s preferences with respect to inflation and there is a fair amount of agreement that inflation targeting unemployment. While some studies have indicated that has been associated with reductions in inflation. Yet, people have an absolute preference for low inflation, in a existing evidence also suggests that inflation targeting has paper written for this project, Arjun Jayadev reports on not yielded inflation rates below the levels attained by the survey results asking people in different countries and industrial non-inflation targeting countries that have income levels what their bigger concern is: high inflation or adopted other monetary regimes. iv high unemployment? viii His main result is that poorer people In addition, there are widely conflicting estimates about are concerned more about high unemployment than high the true costs of inflation targeting on potential and inflation, while richer respondents have the opposite output growth, and little agreement about its impact on preferences. Hence, concerns over employment and employment, poverty and the distribution of income. inflation have an important class dimension. Bernanke, et al. (1999), v despite favoring inflation Most disturbing is the common belief that what is good targeting, report extensive evidence that inflation targeting for developed market economies should simply be central banks do not reduce inflation at a cost lower than replicated by the developing countries as well. Indeed, other countries’ central banks in terms of forgone output. Pollin and Zhu (2006) argue to the contrary. ix Based on non-linear regression estimates of the relationship That is, inflation targeting does not significantly increase between inflation and economic growth for 80 countries the credibility of the central bank and therefore, does not over the period 1961-2000, Pollin and Zhu report that reduce the “sacrifice ratio.” This position has been higher inflation is associated with moderate gains in GDP contradicted by an IMF study, based on an empirical growth up to a roughly 15 to 18 percent inflation model and simulations, suggesting that inflation targeting threshold. Thus, there appears to be no justification for curtails the volatility of inflation, without increasing contractionary inflation targeting policies to maintain volatility in real variables such as real GDP. vi However, these results define stability in a very narrow inflation within a 2 to 4 percent band. sense, failing to consider the issue of the stability of asset prices, including exchange rates, stock prices and other Monetary policy alternatives financial asset prices. More important, as Nelson Barbosa The PERI/Bilkent research suggests a range of policy shows in a paper written for this project, these studies use alternatives, from modest changes within the inflation a biased measure of output stability. vii In particular, they targeting framework to a much broader change in the define “output stability” to mean changes in output relative overall mandate of the central bank to focus on employment to a measure of potential output. The problem is that this rather than inflation targeting. x We begin with proposals complementary to orthodox policy, proceed with a measure of potential output is not fixed: rather, it simply summary of ideas for more far-reaching restructuring of tracks, with a lag, actual output. Therefore, if inflation the monetary framework, and conclude with an overview targeting lowers output growth, then potential output of the main features of both lines of research. growth will soon go down itself, and the gap between In the case of Mexico Galindo and Ros argue that the actual and potential will appear to be unaffected by inflation targeting regime has allowed for more flexible inflation. By this approach, output relative to potential monetary policy than had occurred under regimes with output is virtually guaranteed to be stable no matter how strict monetary targets or strict exchange rate targets. xi restrictive monetary policy is. However, monetary policy appears to have been asymmetric Moreover, our project provides further evidence on the with respect to exchange rate movements—tightening negative consequences of monetary policy focused on when exchange rates depreciated, but not loosening when producing extremely low levels of inflation in the exchange rates appreciated, lending a bias in favor of an developing countries. Braunstein and Heintz (2008) show over-valued exchange rate. Responding symmetrically to that contractionary monetary policy used to fight inflation exchange rate movements and thus avoiding the bias often has a differentially negative impact on the toward over-valuation without fundamentally changing the employment rates of women relative to men. inflation targeting framework “would promote a Furthermore, setting the targeted rate of inflation itself competitive exchange rate by establishing a sliding floor to is immensely problematic. Even though there appears to the exchange rate in order to prevent excessive be a consensus among the advocates of an inflation appreciation,” the authors write. Interventions in foreign targeting regime that the inflation target has to be “in the exchange markets would provide a floor to an otherwise low single digits,” there is no theoretical or empirical freely floating exchange rate, working against excessive justification of this assertion; and as such, it appears to be (speculative) capital inflows to signal that the central bank a recommendation based on ideological motives rather will fight excessive appreciation. xii If needed to stabilize than careful calculation. For example, given the putative ____________________________________________________________________________________________________ G-24 Policy Brief No. 14 2
exchange rates, Galindo and Ros suggest temporary capital comprehensive alternative to inflation targeting for the controls, as do some of the other authors from the case of the Philippines with a strong focus on maintaining a competitive real exchange rate, possibly with PERI/Bilkent project. a peg supported by capital controls. xvii This should include In his study of Brazil Nelson Barbosa-Filho (2008) also proposes to extend the inflation targeting framework, but strong financial supervision to prevent excessive in a more dramatic way. According to Barbosa-Filho, for undertaking of short-term foreign debt, and tax based Brazil, “because of [its] past experience with high inflation, capital controls on short term capital flows, as was used, the best policy is to continue to target inflation while the for example in Chile. Such an exchange rate policy should economy moves to a more stable macroeconomic be complemented by an explicit statement of output and situation.” However, “the crucial question is not to employment goals. Incomes and anti-monopoly policies eliminate inflation targeting, but to actually make it can help to limit inflation to moderate levels and targeted compatible with fast income growth and stable public and credit programs, especially for export oriented and small foreign finance.” Barbosa-Filho proposes to maintain a and medium sized enterprises that can contribute to stable and competitive real exchange rate (SCRER) to productivity growth and employment. promote these goals. The author furthermore suggests These policy proposals in broad outlines are similar to that a targeted reduction in the real interest rate would not those suggested by Epstein (2008) for the case of South Africa. xviii Similarly, Pollin, et al. (2006) developed an only increase productive investment but also reduce the “employment-targeted economic program” designed to burden of servicing Brazil’s large public debt. He proposes accomplish this goal, with a focus on monetary policy, that the Brazilian central bank choose exports, inflation credit policy, capital management techniques, fiscal policy and investment as ultimate targets, and focus on the and industrial policy. xix The purpose of the program is to inflation rate, a competitive and stable real exchange rate reduce the unemployment rate by half in line with the and the real interest rate as intermediate targets. Turkey is another highly indebted country in the government’s pledge to reduce the official unemployment sample. Using a financial-linked computable general rate to 13% by 2014. xx Epstein (2008) proposes that the equilibrium model (CGE), Telli, Voyvoda and Yeldan Reserve Bank of South Africa lower interest rates to target (2008) illustrate the real and financial adjustments of the a higher real GDP growth rate in order to support the Turkish economy under the conditionalities they call the proposed government policy of generating more twin targets of macroeconomic policy xiii —(a) a fiscal target employment, while playing an institutional role in on the primary surplus relative to GNP, and (b) a monetary supporting new credit allocation mechanisms to channel target on the rate of inflation. As a better alternative, they more resources for employment generating activities. The analyze the impact of a shift in policy from a strict inflation Reserve Bank might also need to strengthen capital to an exchange rate targeting regime, combined with a more controls to support the overall program. Here, “employment relaxed fiscal stance (promoting public investments and targeting” replaces inflation targeting as the proposed social capital). Their findings suggest an overall positive operating principle behind central bank policy, and response of economic activity to these alternative moderate inflation becomes an additional formal monetary policy settings. constraint which the central bank must take into account Frenkel and Rapetti (2008) show that targeting a stable when formulating its policies. and competitive real exchange rate has been very The following schematic summarizes the key policy successful in Argentina, xiv helping to maintain more rapid proposals of the PERI/Bilkent project on alternatives to output and employment growth. In the case of India, Jha inflation targeting. (2008) also argues against an inflation targeting regime, Alternatives complementing inflation targeting strategies: and in favor of one that “errs on the side of undervaluation of the exchange rate” with help from ? Adoption of more symmetric inflation targeting: temporary resort to capital controls if necessary, The fundamental importance of gaining and presenting roughly a continuation of policies undertaken maintaining export markets to promote in India in the past. xv In Vietnam, Packard (2005) industrialization and development commends avoiding concludes that “a strict inflation targeting regime is not asymmetric monetary policy that leans against exchange appropriate for Vietnam,” advising that a more exchange rate depreciations but not appreciation, an asymmetry that rate-focused framework would be superior, “precisely eventually leads to harmful exchange rate overbecause it sets as a target a key macroeconomic relative valuation over time. price that is realistic, sustainable, and growth ? Widening of the inflation target band: The enhancing.” xvi developed country band of “acceptable inflation” Other country case studies propose more between 2% and 4% cannot be transplanted to comprehensive policy alternatives to simple inflationdeveloping economies. Research suggests that focused monetary policy. Joseph Lim (2008) proposes a ____________________________________________________________________________________________________ G-24 Policy Brief No. 14 3
somewhat higher inflation can be conducive rather than detrimental to growth and development. The following lists possible elements of an employment targeting and/or growth enhancing rather than inflation targeting monetary policy package: Alternatives replacing inflation targeting strategies: ? Stable and competitive real exchange rate targeting: Maintenance of a stable and competitive real exchange rate, by managing the real exchange rate. ? Employment and growth targets: An explicit statement of goals for output and employment growth as the ultimate measures of development. These will usually require that the central bank expand its policy tool-kit beyond simply manipulating short-term interest rates. This enhanced tool-kit might include: ? Capital account management: Capital controls to support exchange rate management, suppressing “hot money” flows and excessive risk taking. ? Credit policies in support of employment and industrial policies: Targeted credit programs, especially for export oriented and small and medium sized enterprises that can contribute to productivity growth and employment. Concluding Comments In this summary of research conducted at PERI and Bilkent University we have argued that the current orthodoxy of central banking is, especially for developing countries, unlikely to be neither optimal nor desirable. This orthodoxy is based on several false premises: first, that moderate rates of inflation have high costs; second, that in a low inflation environment economies will naturally perform best, and in particular, will generate high levels of economic growth and employment; and third, that there are no viable alternatives to this “inflationfocused” monetary policy. In fact, most moderate rates of inflation episodes reveal to have very low or no costs. To the contrary, there are viable alternatives to inflation targeting, historically, presently, and looking forward. Historically, countries both in the currently developed and developing worlds had central banks with multiple goals and tools, and pursued broad developmental as well as stabilization goals. Currently, very successful economies such as Argentina, China and India have central banks that are using a broad array of tools to manage their economies for developmental purposes. Looking forward, the PERI/Bilkent project on alternatives to inflation targeting and PERI’s UNDP work on South Africa, Kenya and Ghana suggest the availability of an array of “real targeting” approaches. _____________________________________________
Gerald Epstein is Professor of Economics and CoDirector, Political Economy Research Institute at the
University of Massachusetts, Amherst. A. Erinc Yeldan is Professor of Economics, Bilkent University, Ankara and Visiting Professor at Amherst College for 2007/08.
i See Setterfield, Mark (2006) “Is Inflation Targeting Compatible with Post Keynesian Economics?” Journal of Post Keynesian Economics, 28 (4): 653-671, page 653. ii ILO (2004) Global Employment Trends 2004. Geneva: International Labor Office. iii The full set of the country studies of this project can be obtained from PERI (http://www.peri.umass.edu/) or from the International Development Economics Associates (http://www.networkideas.org). These papers will be published in two versions, one in a special issue of The International Review of Applied Economics, March, 2008, and the other in a volume published by Elgar Press in the fall of 2008, entitled Alternatives to Inflation Targeting: Central Bank Policy For Employment Creation, Poverty Reduction And Sustainable Growth. iv See Ball, L. and Sheridan, N. (2003) “Does Inflation Targeting Matter?” IMF Working Paper No. 03/129, and Roger, Scott and Mark Stone (2005) “On Target? The International Experience with Achieving Inflation Targets,” Washington, D.C.: IMF, Working Paper, WP/05/163. v Bernanke, Ben S., Thomas Laubach, Adam S. Posen and Frederic S. Mishkin (1999) Inflation Targeting: Lessons from the International Experience. Princeton, NJ: Princeton University Press. vi Batini, Nicoletta, Peter Breuer, Kalpana Kochhar and Skott Roger (2006) “Inflation Targeting and the IMF” IMF Staff Paper, Washington DC, March. vii Barbosa-Filho, Nelson H. (2008) “Inflation Targeting and Monetary Policy In Brazil.” International Review of Applied Economics, forthcoming. viii Jayadev, Arjun (2008) The Class Content of Preferences Towards AntiInflation and Anti-Unemployment Policies, International Review of Applied Economics, forthcoming. ix Pollin, Robert and Andong Zhu, (2006) “Inflation and Economic Growth: A Cross-Country Nonlinear Analysis.” Journal of Post Keynesian Economics. Summer. Vol. 28, No. 4., pp. 593-614. x It should be emphasized that “inflation control” is an important objective for all the countries studied. Thus, there is a clear consensus among the authors that controlling inflation is important and desirable – even the more comprehensive proposals to target employment are therefore to be understood to address the current imbalance in policy emphasis on inflation, without turning its back on the latter. xi Galindo, L.M. and Ros J. (2008) “Alternatives to Inflation Targeting in Mexico” International Review of Applied Economics, forthcoming. xii For a more formal and theoretical discussion of the macroeconomics of SCRER, see Frenkel and Ros (2006) and Frenkel & Taylor (2006). xiii Telli, Cagatay, Ebru Voyvoda, and Erinc Yeldan (2008) “Macroeconomics of Twin-Targeting in Turkey: Analytics of a Financial CGE Model” International Review of Applied Economics, forthcoming. xiv Frenkel, Roberto and Martin Rapetti (2008) “Five Years of Competitive and Stable Real Exchange Rate in Argentina, 2002-2007” International Review of Applied Economics, forthcoming. xv Jha, Raghbendra (2008) “Inflation Targeting in India: Issues and Prospects” International Review of Applied Economics, forthcoming. xvi Packard, Tu Anh (2005) “Monetary Policy in Vietnam: Alternatives to Inflation Targeting” Presented at the Alternatives to Inflation Targeting Monetary Policy for Stable and Egalitarian Growth in Developing Countries conference, Centro de Estudios de Estado Y Sociedad (CEDES), Buenos Aires, May 13-14, 2005. xvii Lim, Joseph (2008) “A Review of Philippine Monetary Policy Towards An Alternative Monetary Policy” International Review of Applied Economics, forthcoming. xviii Epstein, Gerald, (2008) “Employment Targeting Central Bank Policy in South Africa.” International Review of Applied Economics, forthcoming. xix Pollin, Robert N., Gerald Epstein, James Heintz and Leonce Ndikumana (2006) An Employment-Targeted Economic Program for South Africa; A Study Sponsored by the United Nations Development Program (UNDP), UNDP and the Political Economy Research Institute (PERI). Northampton: E. Elgar Publishers. xx As of March 2007, South Africa had an unemployment rate of anywhere from 20% to 35%, depending on exactly how it is counted.
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doc_569308149.pdf
Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools
G-24
Policy Brief No. 14
Inflation Targeting, Employment Creation and Economic Development
Gerald Epstein and A. Erinc Yeldan
Inflation targeting has become the dominant monetary policy prescription for developing and industrialized countries alike. Initially adopted by New Zealand in 1990, the norms surrounding the inflation targeting regime have been so powerful that virtually all Central Banks have declared that maintaining price stability with inflation in the “low single digits” is their only mandate. It is further maintained that price stability will lead to sustained growth and employment creation. The inflation targeting policy framework involves “the public announcement of inflation targets, coupled with a credible and accountable commitment on the part of government policy authorities to the achievement of these targets”, i with the target usually in the “low single digits.” In addition, inflation targeting is often associated with changes in the central bank law that enhances the independence of the institution. In practice, while few central banks reach the “ideal” of being “full fledged” inflation-targeting institutions, many nonetheless focus on fighting inflation to the virtual exclusion of other goals. Ironically, employment creation has dropped off the immediate agenda of most central banks just as the problems of global unemployment, underemployment and poverty are taking center stage. The ILO estimates that in 2003, approximately 186 million people were jobless, the highest level ever recorded. ii Moreover, the ILO estimates that 22% of the developing world’s workers earn less than $1 a day and 1.4 billion (or 57% of the developing world’s workers) earn less than $2 a day. To reach the Millennium Development Goal of halving the share of working poor by 2015, the ILO’s evaluation shows that on average, real GDP growth has to be maintained at 4.7% per year to reduce the share of “$1 a-day-poverty” by half, and significantly more than that to halve the share of “$2 aday-poverty.” The key problem is that ongoing financial globalization appears primarily to redistribute limited jobs across countries, rather than to accelerate capital accumulation and job creation across the globe. Currently, global growth is highly uneven and geographically too concentrated to generate sufficient jobs world-wide and, moreover, is associated with too little fixed capital formation. Under these conditions, price stability, on its own, will not suffice to maintain true macroeconomic stability, because, it will not secure financial stability and employment growth. As the sub-prime financial crisis originating in the U.S. forcefully exemplifies, it is financial rather than price stability that threatens overall macroeconomic performance. Against this background, the main motivation of the research summarized here is the conviction that modern central banks ought to move beyond a focus solely on low inflation. Instead, central banks—as most did for decades following the Second World War—should strike a balance among various objectives, with employment creation and more rapid economic growth joining inflation and stabilization as possible goals, depending on the circumstances and challenges facing each country. Equally important, to carry out this broader mandate, central banks must have the opportunity to utilize sufficient tools to achieve more objectives. In the following pages, we will summarize the findings of a series of country studies on alternatives to inflation targeting undertaken by a team of researchers organized by PERI (Political Economy Research Institute at the University of Massachusetts, Amherst) and Bilkent University. iii The country studies, produced by a team of country experts, assess the macroeconomic performance of currently existing inflation targeting frameworks, and, more importantly, develop alternative monetary policy frameworks that could better achieve important social and economic goals—all within specific country contexts, including Argentina, Brazil, India, Mexico, The Philippines, Vietnam, South Africa and Turkey. In addition, the project includes several thematic studies relevant to the issue of monetary policy and inflation, including differential gender impacts of contractionary monetary policy, and the impacts of inflation versus economic growth on different income groups within countries. Reporting on the results of this research project, we outline why a shift away from inflation targeting and towards a more balanced approach is both feasible and desirable. Furthermore, to contribute to the task of designing a more socially desirable macroeconomic policy environment, we offer viable alternatives to inflation targeting in order to promote employment, sustained growth, and improved income distribution. Macroeconomic record of inflation targeting Much of the existing literature on the record of inflation targeting has focused on whether inflation and its volatility have been reduced, and whether other objectives, in particular the volatility of output, have been compromised. With respect to the issue of inflation levels,
____________________________________________________________________________________________________ G-24 Policy Brief No. 14 1
a key question is whether inflation has come down in negative costs of inflation on output and employment, response to adoption of the framework itself or due to a there should be some direct survey evidence indicating set of “exogenously welcome” factors. On the one side, people’s preferences with respect to inflation and there is a fair amount of agreement that inflation targeting unemployment. While some studies have indicated that has been associated with reductions in inflation. Yet, people have an absolute preference for low inflation, in a existing evidence also suggests that inflation targeting has paper written for this project, Arjun Jayadev reports on not yielded inflation rates below the levels attained by the survey results asking people in different countries and industrial non-inflation targeting countries that have income levels what their bigger concern is: high inflation or adopted other monetary regimes. iv high unemployment? viii His main result is that poorer people In addition, there are widely conflicting estimates about are concerned more about high unemployment than high the true costs of inflation targeting on potential and inflation, while richer respondents have the opposite output growth, and little agreement about its impact on preferences. Hence, concerns over employment and employment, poverty and the distribution of income. inflation have an important class dimension. Bernanke, et al. (1999), v despite favoring inflation Most disturbing is the common belief that what is good targeting, report extensive evidence that inflation targeting for developed market economies should simply be central banks do not reduce inflation at a cost lower than replicated by the developing countries as well. Indeed, other countries’ central banks in terms of forgone output. Pollin and Zhu (2006) argue to the contrary. ix Based on non-linear regression estimates of the relationship That is, inflation targeting does not significantly increase between inflation and economic growth for 80 countries the credibility of the central bank and therefore, does not over the period 1961-2000, Pollin and Zhu report that reduce the “sacrifice ratio.” This position has been higher inflation is associated with moderate gains in GDP contradicted by an IMF study, based on an empirical growth up to a roughly 15 to 18 percent inflation model and simulations, suggesting that inflation targeting threshold. Thus, there appears to be no justification for curtails the volatility of inflation, without increasing contractionary inflation targeting policies to maintain volatility in real variables such as real GDP. vi However, these results define stability in a very narrow inflation within a 2 to 4 percent band. sense, failing to consider the issue of the stability of asset prices, including exchange rates, stock prices and other Monetary policy alternatives financial asset prices. More important, as Nelson Barbosa The PERI/Bilkent research suggests a range of policy shows in a paper written for this project, these studies use alternatives, from modest changes within the inflation a biased measure of output stability. vii In particular, they targeting framework to a much broader change in the define “output stability” to mean changes in output relative overall mandate of the central bank to focus on employment to a measure of potential output. The problem is that this rather than inflation targeting. x We begin with proposals complementary to orthodox policy, proceed with a measure of potential output is not fixed: rather, it simply summary of ideas for more far-reaching restructuring of tracks, with a lag, actual output. Therefore, if inflation the monetary framework, and conclude with an overview targeting lowers output growth, then potential output of the main features of both lines of research. growth will soon go down itself, and the gap between In the case of Mexico Galindo and Ros argue that the actual and potential will appear to be unaffected by inflation targeting regime has allowed for more flexible inflation. By this approach, output relative to potential monetary policy than had occurred under regimes with output is virtually guaranteed to be stable no matter how strict monetary targets or strict exchange rate targets. xi restrictive monetary policy is. However, monetary policy appears to have been asymmetric Moreover, our project provides further evidence on the with respect to exchange rate movements—tightening negative consequences of monetary policy focused on when exchange rates depreciated, but not loosening when producing extremely low levels of inflation in the exchange rates appreciated, lending a bias in favor of an developing countries. Braunstein and Heintz (2008) show over-valued exchange rate. Responding symmetrically to that contractionary monetary policy used to fight inflation exchange rate movements and thus avoiding the bias often has a differentially negative impact on the toward over-valuation without fundamentally changing the employment rates of women relative to men. inflation targeting framework “would promote a Furthermore, setting the targeted rate of inflation itself competitive exchange rate by establishing a sliding floor to is immensely problematic. Even though there appears to the exchange rate in order to prevent excessive be a consensus among the advocates of an inflation appreciation,” the authors write. Interventions in foreign targeting regime that the inflation target has to be “in the exchange markets would provide a floor to an otherwise low single digits,” there is no theoretical or empirical freely floating exchange rate, working against excessive justification of this assertion; and as such, it appears to be (speculative) capital inflows to signal that the central bank a recommendation based on ideological motives rather will fight excessive appreciation. xii If needed to stabilize than careful calculation. For example, given the putative ____________________________________________________________________________________________________ G-24 Policy Brief No. 14 2
exchange rates, Galindo and Ros suggest temporary capital comprehensive alternative to inflation targeting for the controls, as do some of the other authors from the case of the Philippines with a strong focus on maintaining a competitive real exchange rate, possibly with PERI/Bilkent project. a peg supported by capital controls. xvii This should include In his study of Brazil Nelson Barbosa-Filho (2008) also proposes to extend the inflation targeting framework, but strong financial supervision to prevent excessive in a more dramatic way. According to Barbosa-Filho, for undertaking of short-term foreign debt, and tax based Brazil, “because of [its] past experience with high inflation, capital controls on short term capital flows, as was used, the best policy is to continue to target inflation while the for example in Chile. Such an exchange rate policy should economy moves to a more stable macroeconomic be complemented by an explicit statement of output and situation.” However, “the crucial question is not to employment goals. Incomes and anti-monopoly policies eliminate inflation targeting, but to actually make it can help to limit inflation to moderate levels and targeted compatible with fast income growth and stable public and credit programs, especially for export oriented and small foreign finance.” Barbosa-Filho proposes to maintain a and medium sized enterprises that can contribute to stable and competitive real exchange rate (SCRER) to productivity growth and employment. promote these goals. The author furthermore suggests These policy proposals in broad outlines are similar to that a targeted reduction in the real interest rate would not those suggested by Epstein (2008) for the case of South Africa. xviii Similarly, Pollin, et al. (2006) developed an only increase productive investment but also reduce the “employment-targeted economic program” designed to burden of servicing Brazil’s large public debt. He proposes accomplish this goal, with a focus on monetary policy, that the Brazilian central bank choose exports, inflation credit policy, capital management techniques, fiscal policy and investment as ultimate targets, and focus on the and industrial policy. xix The purpose of the program is to inflation rate, a competitive and stable real exchange rate reduce the unemployment rate by half in line with the and the real interest rate as intermediate targets. Turkey is another highly indebted country in the government’s pledge to reduce the official unemployment sample. Using a financial-linked computable general rate to 13% by 2014. xx Epstein (2008) proposes that the equilibrium model (CGE), Telli, Voyvoda and Yeldan Reserve Bank of South Africa lower interest rates to target (2008) illustrate the real and financial adjustments of the a higher real GDP growth rate in order to support the Turkish economy under the conditionalities they call the proposed government policy of generating more twin targets of macroeconomic policy xiii —(a) a fiscal target employment, while playing an institutional role in on the primary surplus relative to GNP, and (b) a monetary supporting new credit allocation mechanisms to channel target on the rate of inflation. As a better alternative, they more resources for employment generating activities. The analyze the impact of a shift in policy from a strict inflation Reserve Bank might also need to strengthen capital to an exchange rate targeting regime, combined with a more controls to support the overall program. Here, “employment relaxed fiscal stance (promoting public investments and targeting” replaces inflation targeting as the proposed social capital). Their findings suggest an overall positive operating principle behind central bank policy, and response of economic activity to these alternative moderate inflation becomes an additional formal monetary policy settings. constraint which the central bank must take into account Frenkel and Rapetti (2008) show that targeting a stable when formulating its policies. and competitive real exchange rate has been very The following schematic summarizes the key policy successful in Argentina, xiv helping to maintain more rapid proposals of the PERI/Bilkent project on alternatives to output and employment growth. In the case of India, Jha inflation targeting. (2008) also argues against an inflation targeting regime, Alternatives complementing inflation targeting strategies: and in favor of one that “errs on the side of undervaluation of the exchange rate” with help from ? Adoption of more symmetric inflation targeting: temporary resort to capital controls if necessary, The fundamental importance of gaining and presenting roughly a continuation of policies undertaken maintaining export markets to promote in India in the past. xv In Vietnam, Packard (2005) industrialization and development commends avoiding concludes that “a strict inflation targeting regime is not asymmetric monetary policy that leans against exchange appropriate for Vietnam,” advising that a more exchange rate depreciations but not appreciation, an asymmetry that rate-focused framework would be superior, “precisely eventually leads to harmful exchange rate overbecause it sets as a target a key macroeconomic relative valuation over time. price that is realistic, sustainable, and growth ? Widening of the inflation target band: The enhancing.” xvi developed country band of “acceptable inflation” Other country case studies propose more between 2% and 4% cannot be transplanted to comprehensive policy alternatives to simple inflationdeveloping economies. Research suggests that focused monetary policy. Joseph Lim (2008) proposes a ____________________________________________________________________________________________________ G-24 Policy Brief No. 14 3
somewhat higher inflation can be conducive rather than detrimental to growth and development. The following lists possible elements of an employment targeting and/or growth enhancing rather than inflation targeting monetary policy package: Alternatives replacing inflation targeting strategies: ? Stable and competitive real exchange rate targeting: Maintenance of a stable and competitive real exchange rate, by managing the real exchange rate. ? Employment and growth targets: An explicit statement of goals for output and employment growth as the ultimate measures of development. These will usually require that the central bank expand its policy tool-kit beyond simply manipulating short-term interest rates. This enhanced tool-kit might include: ? Capital account management: Capital controls to support exchange rate management, suppressing “hot money” flows and excessive risk taking. ? Credit policies in support of employment and industrial policies: Targeted credit programs, especially for export oriented and small and medium sized enterprises that can contribute to productivity growth and employment. Concluding Comments In this summary of research conducted at PERI and Bilkent University we have argued that the current orthodoxy of central banking is, especially for developing countries, unlikely to be neither optimal nor desirable. This orthodoxy is based on several false premises: first, that moderate rates of inflation have high costs; second, that in a low inflation environment economies will naturally perform best, and in particular, will generate high levels of economic growth and employment; and third, that there are no viable alternatives to this “inflationfocused” monetary policy. In fact, most moderate rates of inflation episodes reveal to have very low or no costs. To the contrary, there are viable alternatives to inflation targeting, historically, presently, and looking forward. Historically, countries both in the currently developed and developing worlds had central banks with multiple goals and tools, and pursued broad developmental as well as stabilization goals. Currently, very successful economies such as Argentina, China and India have central banks that are using a broad array of tools to manage their economies for developmental purposes. Looking forward, the PERI/Bilkent project on alternatives to inflation targeting and PERI’s UNDP work on South Africa, Kenya and Ghana suggest the availability of an array of “real targeting” approaches. _____________________________________________
Gerald Epstein is Professor of Economics and CoDirector, Political Economy Research Institute at the
University of Massachusetts, Amherst. A. Erinc Yeldan is Professor of Economics, Bilkent University, Ankara and Visiting Professor at Amherst College for 2007/08.
i See Setterfield, Mark (2006) “Is Inflation Targeting Compatible with Post Keynesian Economics?” Journal of Post Keynesian Economics, 28 (4): 653-671, page 653. ii ILO (2004) Global Employment Trends 2004. Geneva: International Labor Office. iii The full set of the country studies of this project can be obtained from PERI (http://www.peri.umass.edu/) or from the International Development Economics Associates (http://www.networkideas.org). These papers will be published in two versions, one in a special issue of The International Review of Applied Economics, March, 2008, and the other in a volume published by Elgar Press in the fall of 2008, entitled Alternatives to Inflation Targeting: Central Bank Policy For Employment Creation, Poverty Reduction And Sustainable Growth. iv See Ball, L. and Sheridan, N. (2003) “Does Inflation Targeting Matter?” IMF Working Paper No. 03/129, and Roger, Scott and Mark Stone (2005) “On Target? The International Experience with Achieving Inflation Targets,” Washington, D.C.: IMF, Working Paper, WP/05/163. v Bernanke, Ben S., Thomas Laubach, Adam S. Posen and Frederic S. Mishkin (1999) Inflation Targeting: Lessons from the International Experience. Princeton, NJ: Princeton University Press. vi Batini, Nicoletta, Peter Breuer, Kalpana Kochhar and Skott Roger (2006) “Inflation Targeting and the IMF” IMF Staff Paper, Washington DC, March. vii Barbosa-Filho, Nelson H. (2008) “Inflation Targeting and Monetary Policy In Brazil.” International Review of Applied Economics, forthcoming. viii Jayadev, Arjun (2008) The Class Content of Preferences Towards AntiInflation and Anti-Unemployment Policies, International Review of Applied Economics, forthcoming. ix Pollin, Robert and Andong Zhu, (2006) “Inflation and Economic Growth: A Cross-Country Nonlinear Analysis.” Journal of Post Keynesian Economics. Summer. Vol. 28, No. 4., pp. 593-614. x It should be emphasized that “inflation control” is an important objective for all the countries studied. Thus, there is a clear consensus among the authors that controlling inflation is important and desirable – even the more comprehensive proposals to target employment are therefore to be understood to address the current imbalance in policy emphasis on inflation, without turning its back on the latter. xi Galindo, L.M. and Ros J. (2008) “Alternatives to Inflation Targeting in Mexico” International Review of Applied Economics, forthcoming. xii For a more formal and theoretical discussion of the macroeconomics of SCRER, see Frenkel and Ros (2006) and Frenkel & Taylor (2006). xiii Telli, Cagatay, Ebru Voyvoda, and Erinc Yeldan (2008) “Macroeconomics of Twin-Targeting in Turkey: Analytics of a Financial CGE Model” International Review of Applied Economics, forthcoming. xiv Frenkel, Roberto and Martin Rapetti (2008) “Five Years of Competitive and Stable Real Exchange Rate in Argentina, 2002-2007” International Review of Applied Economics, forthcoming. xv Jha, Raghbendra (2008) “Inflation Targeting in India: Issues and Prospects” International Review of Applied Economics, forthcoming. xvi Packard, Tu Anh (2005) “Monetary Policy in Vietnam: Alternatives to Inflation Targeting” Presented at the Alternatives to Inflation Targeting Monetary Policy for Stable and Egalitarian Growth in Developing Countries conference, Centro de Estudios de Estado Y Sociedad (CEDES), Buenos Aires, May 13-14, 2005. xvii Lim, Joseph (2008) “A Review of Philippine Monetary Policy Towards An Alternative Monetary Policy” International Review of Applied Economics, forthcoming. xviii Epstein, Gerald, (2008) “Employment Targeting Central Bank Policy in South Africa.” International Review of Applied Economics, forthcoming. xix Pollin, Robert N., Gerald Epstein, James Heintz and Leonce Ndikumana (2006) An Employment-Targeted Economic Program for South Africa; A Study Sponsored by the United Nations Development Program (UNDP), UNDP and the Political Economy Research Institute (PERI). Northampton: E. Elgar Publishers. xx As of March 2007, South Africa had an unemployment rate of anywhere from 20% to 35%, depending on exactly how it is counted.
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