It Frameworks Essay

3884 WordsMar 30, 201216 Pages
H T Parekh finance forum Inflation Targeting International Experience and Prospects for India The inflation targeting framework has been successfully implemented in several developed and developing countries. However, the success of this system requires equal commitment from the government and the central bank. In the case of India, targeting inflation is politically sustainable given the overwhelming preference of the population for lower headline inflation. KANHAIYA SINGH money demand growth unpredictable. Many economies which opted for exchange rate pegs as the instrument of price stability, became excessively vulnerable to large swings in capital flows. Nominal income targeting could not sustain some of the theoretical scrutiny (model inconsistency) and implementation problems arose out of lags in information on price and nominal income as also the effects of productivity shocks.2 However, of late it appears that the central banks have finally discovered their favourite anchor in “forecasted inflation” under the newfound regime of “inflation targeting” (IT), even while some academicians remain sceptical about the efficacy of this regime. The first country to adopt IT was New Zealand in 1990 and by the end of 2005, the list of countries following IT has increased many fold, which includes several emerging market economies. At the heart of the concept of the inflation targeting problem [Svensson 1999] is the following equation: πt + 2 t − π* = −Φ y∆+1 t t where, π* is the long-run unconditional and socially optimal inflation target; y ∆ is t output gap (log actual relative to potential output); πt = pt – pt–1 is inflation rate; Φ is a positive parameter which is a function of the weight on output stabilisation, discount factor of the inter-temporal objective function and supply function parameter of the output gap; and pt is log of price level. The

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