## Perspectives and Lessons from Country Experiences with Inflation Targeting, Remarks at a Panel on Inflation Targeting, by Mr. Murilo Portugal, Deputy Managing Director, IMF _IMF News, May 17, 2007_ ## Source details **Canonical URL:** [Perspectives and Lessons from Country Experiences with Inflation Targeting, Remarks at a Panel on Inflation Targeting, by Mr. Murilo Portugal, Deputy Managing Director, IMF](https://www.imf.org/en/news/articles/2015/09/28/04/53/sp051707) ## Other formats - [Markdown version](/en/news/articles/2015/09/28/04/53/sp051707/index.md) - [Structured JSON version](/en/news/articles/2015/09/28/04/53/sp051707/index.json) - [Bundle manifest](/en/news/articles/2015/09/28/04/53/sp051707/bundle-manifest.json) ## Bibliographic details - Authors: Murilo Portugal Deputy Managing Director - Published: May 17, 2007 --- ### Overview and purpose - Remarks delivered at a panel on inflation targeting, employment creation, and economic development. - Focus: address whether inflation targeting is compatible with growth, employment, and poverty reduction; how it can be adapted to take account of employment, competitiveness, and growth; and whether reasonable alternatives exist given increased international integration. - Empirical base: experience of inflation targeting in emerging market economies over the prior decade. ### Spread of inflation targeting - First adopted by New Zealand in 1990. - Adopted by 24 countries, of which 16 are emerging market and developing economies. - Expectation: more emerging market and developing countries likely to move to inflation targeting within the next 10 years. - Four main factors driving adoption: - High and unpredictable inflation in the 1970s and 1980s undermined sustainable growth, external competitiveness, and employment. - Financial innovation weakened the reliability of money and credit aggregates as intermediate targets. - Greater international integration (goods and financial markets) made flexible exchange rates and a new nominal anchor more attractive. - Perceived success in industrial countries: credibility, flexibility, better inflation and growth performance, and resilience to shocks, aided by policy transparency. ### Empirical experience in emerging market and developing economies - Comparison of periods: most emerging market and developing countries performed much better in growth and inflation since 2000 than during the 1990s. - Inflation reductions: inflation targeters typically cut inflation from over 10 percent per annum to around 4 percent—roughly twice the reduction achieved by non-inflation targeters. - Growth: both targeters and non-targeters enjoyed increases in real GDP growth rates, typically around 2/3 of a percentage point; differences in growth between groups were not statistically significant. - Targeting practice: - Neither industrial nor emerging market inflation targeters pursue strict short-term-only inflation targeting. - Inflation targeters miss their targets far more often—around one-third of the time—and for long enough that strict targeting is not observed in practice. - Emerging market inflation targeters typically experience lower variability of both growth and inflation than emerging markets with other monetary policy regimes. - Overall empirical implication: flexible inflation targeting has been associated with substantial reductions in inflation without significant cost in terms of growth. ### Flexibility and policy design choices under inflation targeting - Elements of flexibility that can be adapted to country circumstances: - Choice of price index (core vs. headline) depending on which better predicts future inflation. - Numerical value of the target and the width of the tolerance band (wider bands for countries prone to external and supply shocks). - Horizon for achieving the target, matched to the country-specific lags in the monetary policy transmission mechanism. - Forward-looking stance: ability to choose which shocks to respond to and over what period, conditional on well-anchored inflation expectations. - Credibility and expectations: - The real anchor of the system is the credibility of the central bank's commitment to the inflation target. - Well-anchored inflation expectations allow lengthening of maturities of fixed-rate instruments and can support long-term financing and growth. ### Challenges and problematic issues observed - Exchange rate versus inflation objective: - Difficulty for central banks transitioning from exchange rate pegs to subordinating exchange rate and competitiveness concerns to the inflation objective. - Market testing of central-bank commitment to inflation targeting has occurred in countries such as Chile, Hungary, and Romania. - Long-term competitiveness is fundamentally a productivity issue; weak exchange rates can provide only temporary competitiveness gains. - Shifts in investor sentiment and capital flows: - Inflation targeters are vulnerable to disruptive shifts in investor sentiment affecting exchange markets, growth, and inflation. - Episodes of strong capital inflows have put upward pressure on exchange rates and led to ballooning current account imbalances or foreign exchange reserves. - Central banks have sometimes responded with intervention, administrative measures, or restrictions to slow short-term capital inflows. - Domestic political or fiscal concerns have also triggered turbulence in cases such as Brazil in 2002 and the Philippines; Iceland experienced exchange market pressure linked to large current account imbalances and banking sector vulnerabilities. - Despite pressures, such episodes have not led to breakdowns of inflation-targeting frameworks; they can strengthen policy credibility if the central bank maintains focus on the inflation objective. - Limitations: - Inflation targeting is not a panacea for insulating a country from external financial disturbances or real exchange rate influences on competitiveness; it performs similarly to alternative regimes in this respect. ### Preconditions and minimum institutional requirements - Three minimum requirements for successful adoption: - Central bank autonomy and associated accountability to pursue a clear mandate, with government support in words and deeds; fiscal discipline contributes significantly to credibility. - Effective instruments for influencing domestic spending and savings, which generally require functioning financial markets and a reasonably stable financial system. - Adequate economic and financial data, analytical capacity, and a reasonable understanding of monetary transmission to respond in a timely manner to inflation pressures. - Trade-offs and adaptability: - Countries further along in developing these elements prior to adoption are likely to achieve greater credibility and better macroeconomic performance. - However, successful adoption has occurred across widely differing initial conditions, illustrating the framework's flexibility and adaptability. ### Key findings and policy implications - No medium- to long-term trade-off between low inflation and growth; a credible commitment to low inflation is good for long-term growth. - Flexible inflation targeting that takes short-term output and employment consequences into account is the prevalent and practical approach. - Inflation targeting can achieve substantial reductions in inflation without significant growth costs when pursued flexibly. - Central bank credibility, fiscal discipline, functional financial markets, data and analytical capacity are important enablers. - Inflation targeting does not eliminate vulnerability to capital-flow volatility or exchange rate pressures; policy responses must weigh temporary vs. persistent effects and consider implications for productive capacity. *Source: Remarks at a Panel on Inflation Targeting by Mr. Murilo Portugal, Deputy Managing Director, International Monetary Fund, Washington D.C., May 17, 2007.* --- ## References - [Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm) - [Chile and the IMF](http://www.imf.org/external/country/CHL/index.htm) - [Portugal and the IMF](http://www.imf.org/external/country/PRT/index.htm) - [Thailand and the IMF](http://www.imf.org/external/country/THA/index.htm) - [Speeches](https://www.imf.org/en/news/searchnews) - [Murilo Portugal](https://www.imf.org/external/np/omd/bios/mp.htm) - [PRESS CENTER](http://presscenter.imf.org/) - [https://www.imf.org/en/home](https://www.imf.org/en/home) _Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp051707_