Flexible Inflation Targeting

By: EconomyWatch   Date: 14 October 2010

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The flexible inflation targeting is set, when the central bank of any country primarily concerned with factors like stability of interest rates, exchange rates, output and employment. On the contrary, strict inflation targeting is set, when the central bank concentrates on maintaining and achieving inflation, close to the target inflation.
Strict vs flexible inflation targeting
The countries that adopt inflation targeting, normally opt for inflation targets, ranging from 1.5 percent to 2.5 percent (1.5% per year in New Zealand, 2% in Canada, Sweden and Finland, 2.5% per year in Britain and Australia). Experts argument that for a given bandwidth, difference between a midpoint of 1.5 or 2.5 does not matter much. No concrete evidence has yet been observed, where a 2.5% inflation target brought better performance of the economy. Although there is evidence, where a considerable higher inflation restrained long-run growth.

Observations
While choosing between strict and flexible inflation, the central bank normally considers about whether the inflation targeted at the longer horizon or shortest possible horizon. It has been observed that Central bank of New Zealand pursued flexible inflation targeting. The flexible inflation targeting in New Zealand aimed at the inflation target at a longer horizon. Although it has observed that too much of flexibility caused the public to doubt the bank's commitment in achieving the inflation target. This will also reduce the credibility of the inflation target.
Advice by experts
Experts advice that inflation targeting should not be a strict inflation targeting but a flexible inflation targeting. This is because of the fact that Central bank always aims at stabilizing inflation around the inflation target and at the same time put some weight on stabilizing the real economy. That is why, the objective of the central bank is not only to achieve the inflation target, but also to control other variables like output gap.


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