Inflation Target and Monetary Policy

Readers Question: Explain how monetary policy works under an inflation targeting Regime.

I have written some answers to this question on previous occassions. These answers should help:

• How MPC set Interest Rates 
• The MPC and the setting of Interest rates 
• MPC and Inflation Forecasts
  

Meaning of Inflation Targetting

Inflation Targetting means that the Central Bank has a sole objective of achieving the Government’s inflation target. This means in theory they do not target other macroeconomic objectives like unemployment and growth (although in practice they may worry about a recession).

It also means they don’t target inflation indirectly. e.g. fixing currency or targetting money supply.

 Inflation Targetting in UK

Since 1997, the UK has been a good example of Inflation Targetting.

The government set the inflation target CPI 2% +/-1

Monetary policy is operated by an independent Bank of England. This means the government cannot interfere in Monetary policy decisions.

The MPC use interest rates to try an achieve this goal.

It is hoped that having an inflation target will reduce inflation expectations and therefore make it easier to maintain low inflation

Inflation Targetting in US.

In US the policy is slightly different because the Fed have 2 objectives. One is to target low inflation, the other is to maintain full employment. At the moment the Fed is cutting interest rates to try and avoid recession, they are not too worried if inflation increases