Inflation Targeting in Emerging Market Economies

By: EconomyWatch   Date: 14 October 2010

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Inflation Targeting in Emerging Market Economies has helped to reduce the average inflation to make their economic structure better. Due to an unstable and disturbing political condition for a long time, the developing countries have suffered many economic problems, like high and volatile inflation rate and less credibility of the monetary policies.

Countries like Brazil, Peru, Hungary, Colombia, Thailand,Chile, Israel, South Korea, Mexico are the Emerging Market Economies.

Approach Towards Inflation Targeting:

Inflation Targeting is important in the Emerging Market Economies mainly to combat high inflation as well as to establish credibility of the monetary policy. Another reason why the concept of inflation targeting has assumed importance is its dealing with the problem of financial dominance. The main reasons behind inflation targeting are:

  1. To improve credibility: In order to reach the target the Central Bank has to combat the shocks of inflation which, in turn, will improve their credibility. Bank should keep it's promises and, if the inflation rate goes beyond the target it will have to act accordingly to make the price level steady. In a country like Brazil, the Central Bank has shown a lot of creditability by acquiring a transparent monetary policy through inflation targeting.
     
  2. To avoid dominances: Dominances are of many types like external dominance, fiscal dominance, financial dominance etc. Financial and fiscal dominance emerge from monetary policy and can make the expected inflation high.

    So a better monetary policy is required to avoid dominance. Short term financial agreements are also a kind of financial dominance which disturb the making of a good monetary policy in the Emerging Market Economies.

    External dominance occurs when the inflow of capital gets halted suddenly. This phenomena is called a 'shock'. Bank or Government has to combat these shocks by formulating a better economic policy.
     

  3. To deal with volatile inflation rate: In the developing countries volatile inflation leads to an unstable price which decreases the credibility as well as the accountability of the Bank.
Summary:

Despite the fact that inflation targeting in Emerging Market Economies is a difficult task, it has succeeded to build a firm economic structure. Inflation targeting has also helped the Emerging Market Economies to stabilise the price rates. These countries now have decreased the inflation rate and got back the credibility regarding fiscal issues. The inflation performance has improved to assess the monetary policy. A framework to build a transparent monetary policy to focus on the bank's accountability has been structured. It will be able to combat the sudden shocks as well.


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