Experience yields practical suggestions for emerging market countries

• Author: Andrea Schaechter; Mark Stone; Mark Zelmer
• Position: IMF, Monetary and Exchange Affairs Department
• Pages: 348-349

Page 348

Anew study by three economists in the Monetary Operations Division of the IMF’s Monetary and Exchange Affairs Department highlights practical suggestions on inflation targeting that could be particularly useful for emerging market countries. The paper, forthcoming in the IMF Occasional Papers series, taps the years of experience industrial countries have had with inflation targeting, as well as the more recent formulation of inflation targeting frameworks by emerging market countries.

In recent years, emerging market countries have joined industrial countries in adopting formal inflation targeting monetary policy frameworks. (See related stories, IMF Survey, February 7, page 37, and April 3, page 103.) Brazil, Chile, the Czech Republic, Israel, Poland, and South Africa have adopted inflation targeting, while other countries, such as Mexico and Thailand, are in the process of doing so.

The experiences of the countries examined suggest that the foundation for successful, full-fledged inflation targeting consists of a strong fiscal position and entrenched macroeconomic stability; a well-developed financial system; central bank instrument independence and a mandate to achieve price stability; a reasonably well-understood transmission mechanism between monetary policy actions and their effects on inflation; a sound methodology for constructing inflation forecasts; and transparency of monetary policy to build accountability and credibility. Many of these elements, especially a strong fiscal position, are needed for sound monetary policy, regardless of the policy objective. In addition, these elements do not need to be in place before a country begins the transition toward full-fledged inflation targeting.

Framework

Under inflation targeting, the legal framework for central banks defines the objectives of monetary policy and provides the central bank with the scope to meet them. Countries usually modify their legal frameworks before adopting inflation targeting. All inflation targeting central banks have effective instrument independence—that is, they are free to choose how they will set their instruments, such as interest rates, to achieve their goal. All countries that adopt inflation targeting specify price or currency stability as a central bank objective—most, but not all, adopt it as the principal objective––reflecting the trade-off between the credibility gains...