Inflation Targeting Questioned

The “inflation nutters”, as Samuel Brittan calls them, are out in force. The Bank of England is being criticised for its recent inability to predict nor manage the UK’s 2% inflation target. According to the Bank website, “Low inflation is not an end in itself. It is however an important factor in helping to encourage long-term stability in the economy”. The two charts shown here raise some questions about that statement, and the entire premise of Inflation Targeting (IT).

The first chart shows the unemployment rate in the five years before and after implementation of IT across a sample of 21 countries. Notably only four showed a decline of more than 1% in unemployment over the period while 10 showed an increase of 1% or more, in some cases significantly so.

Chart: Unemployment rate 5 years before and after Inflation Targeting*
Unemployment rate 5 years before and after Inflation Targeting*

The second chart shows growth figures for the same date range. Here the results are mixed; only one third of the countries sampled experienced lower growth after implementation of IT.

Chart: Growth rate 5 years before and after Inflation Targeting*

Growth rate 5 years before and after Inflation Targeting*

The research, Inflation Targeting, Employment Creation and Economic Development was published in 2007 by Gerald Epstein, Professor of Economics at the University of Massachusetts, Amherst. Epstein remarks as follows:

“Despite the inconclusive verdict on the growth front the figures on unemployment indicate a significant increase in the post-IT era… The increased severity of unemployment at the global scale seems to have affected the IT-countries equally strongly, and the theoretical expectation that “price stability would bring growth and employment in the long run” seems quite far from being materialized yet.”

The picture for the UK is better then for most of the sample, but far from spectacular. While unemployment dropped by 2.2%  growth was a mere 0.5%. Given these figures, and in these extraordinary times, should the Bank stick so doggedly to the inflation target?

*Chart notes:

Source: IMF Statistics and Asian Development Bank in Epstein 2007

i-The period before the inflation targeting refers the period of 94-97 for Growth and CPI in Czech growth

ii-The period before the inflation targeting refers the period of 96-98 for reserves in Brazil

iii- The period before the inflation targeting refers the period of 94-97 and after inflation targeting refers the period of 99-04 for unemployment rate in South Africa. The change method of unemployment change after the aphertheid regime can be seen here

iv-The period after the inflation targeting refers the period of 03-04 for unemployment rate in Peru.

v-Official adoption date for Turkey is 2006. However, Turkish CB declared “disguised inflation targeting” in the aftermath of the 2001 February crisis

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About Gideon Benari
Solvency II Wire a site dedicated to informing professionals in financial services industry about Solvency II, the new regulation for the European insurance industry.

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