Strategies For Controlling Inflation

Seaport (Villa Medici) (1637)

Abstract

Inflation, which is defined by Frederic Mishkin (2007) as the condition of a continually and rapidly rising price level is similar in some sense as water is to human beings. Too much water (hyperinflation) causes massive floods while the lack of water or the absence of water (deflation) causes droughts. What is required is a steady and constant supply of water which central banks commonly refer to as low and stable inflation. Frederic Mishkin (2000) stated that price stability (which is obtained through a low and stable inflation) should be the overriding, long-run goal of monetary policy. Knowing this to be true, the understanding of the various strategies that central banks can use to control inflation becomes of outmost importance for modern economists. This working paper would have achieved its purpose should it successfully give an equal argument on the advantages and disadvantages of each policy (as written by Frederic Mishkin’s 1997 working paper) and also to highlight some of the inflationary challenges that we shall all face in the coming years.

Please click the link below to view working paper:

Strategies For Controlling Inflation

Comments
2 Responses to “Strategies For Controlling Inflation”
  1. hishamh says:

    Hope you don’t mind but a few comments:

    1. Hong Kong is an example of a currency board that has been adhered to successfully over the long term. Singapore has used a crawling peg since the 1980s.

    2. I’m probably splitting hairs here, but I would divide “inflation targeting” in the paper to “interest rate targeting” and “inflation targeting”. The difference between the two would be the absence or presence of an explicit inflation target respectively. The impact is different between the two regimes because of differences in the formation of inflation expectations. Interest rate targeting would also be more applicable if central banks have a dual mandate of price stability and growth, rather than just price stability e.g. BNM and the Federal Reserve.

    3. The failure of monetary base targeting is an application of Goodhart’s Law. The problem wasn’t the lack of a reliable relationship between monetary aggregates and real variables, but rather that the relationships broke down when money was used as the target variable.

    4. Incidentally, you can see this empirically – whichever variable is chosen as the policy instrument results in high volatility in the other monetary variables, i.e. an exchange rate target results in high volatility in interest rates and monetary aggregates, an interest rate target results in high volatility in exchange rates and monetary aggregates. For the theoretical basis, look up Mundell-Fleming.

    • jamesesz says:

      Dear Hisham!

      This is excellent food for thought! In my opinion, Hong Kong and Singapore is successful due to their relative size and island-economy.

      I agree with the split between interest rate targeting and inflation targeting.

      Thanks so much!

      PS: Look out for my report on the NEM!

      Yours faithfully,
      Ee Suen Zheng

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