Setting Inflation Target Remains an Effective Tool

Central bankers discuss experiences with inflation-forecast targeting

Participating countries face serious post-crisis challenges, fragile recovery

Change in mindset, clear communications, better analytical tools are required

But for this method to succeed, policymakers must change their mindset and embrace flexible exchange rates, communicate more clearly, and strengthen their analytical tools.

These were some of the key conclusions of central bankers and other policymakers from emerging Europe, Central Asia, and the Caucasus as they gathered in late April to share their experiences with inflation-forecast targeting. The eight-day workshop—held in Yerevan and Tshakhkadzor, Armenia—was jointly organized by the International Monetary Fund, the European Bank for Reconstruction and Development, and the Central Bank of Armenia.

As with traditional inflation targeting, a central bank using inflation-forecast targeting adopts a formal, public target for the inflation rate and then attempts to steer actual inflation toward the target through the use of interest rate changes and other monetary instruments.

However, this type of targeting involves greater degree of transparency and communication of monetary policy decisions, centered on publication of a forecast for inflation and interest rates (or assumptions underpinning the forecast). At times, the inflation forecast may represent an intermediate target that the central bank aims to bring back to the formal target over time.

Other hallmarks of the regime—which evolved from traditional inflation targeting—are public discussion of the forecasts, communicating the reasons for missed targets, and explaining how policy will act to return inflation to the target in the future.

Difficult times

Central banks in emerging Europe, Central Asia and the Caucasus face difficult challenges. The recovery is fragile, some economies are highly dollarized, financial sectors remain underdeveloped and in some cases impaired from the crisis, and fiscal space is limited. The region has been confronted by volatile capital flows and a large increase in food and fuel prices—a phenomenon that is strongly felt by consumers in these countries, who spend a large proportion of their income on food.

These challenges—particularly the emerging threat of inflation—provided the impetus for the conference.

Conference organizers Douglas Laxton of the IMF’s Research Department, Mark Horton of the IMF’s Middle East and...