Inflation Targeting In A Context Of Crisis

This article, firstly written in French, was published in a Moroccan Journal "LE SOIR ECHOS", n° 254 February 13th, 2009 Dr. Kamal El-OUALY Economist [email protected]

Inflation targeting in a context of crisis (*) During these fifteen last years, the theory of the monetary policy underwent a recasting of its old concepts in particular with the appearance of new rules dictated by the emergence of a new consensus of monetary policy centered on the direct inflation targeting as a new monetary policy strategy. This approach, primarily founded on the forecast of inflation, acts as a process in which the instrument of the monetary policy is adjusted to keep the inflation anticipated on its target level. The target of inflation control is considered as a framework that offer more economic and financial judicious decision and tend to increase the transparency and the credibility of the monetary policy. By making inflation as a principal objective, this new framework of monetary policy constitutes an alternative anchor to the other forms of nominal anchoring, such as the exchange rate target and the monetary aggregate target, which appeared increasingly difficult to implement. In addition, the inflation-targeting regime cannot be implemented without the respect of some institutional and technical prerequisites. The experiment of several countries also teaches us that a certain number of challenges deserve to be noted before choosing to practice this monetary policy framework definitively. On the practical level, this revival of the monetary policy regime seems to constitute a world tendency during the last decade in particular with the adhesion of a significant number of emerging countries to the group of the developed countries, which have chosen the inflation targeting since the beginning of 1990. However, this quasi-unanimous reference to the same mode for the control of the monetary policy pleads for research about the practical scope of inflation targeting in a turbulent world

economic context. Which lesson at least could we draw from its implementation until the bursting of the financial crisis in 2008 and its economic repercussions, which are announced negative during 2009 ? At the beginning, the inflation-targeting regime was implemented during a period marked by a fall of inflation. However, in order to reveal its efficiency; this monetary policy strategy should be practiced in a more turbulent context. It is important to show that during the period 2007-2008, this new monetary consensus centered on the inflation anchoring failed in two successive periods: - The first period marked by the resurgence of inflation throughout the world, in particular with the rise of the energy prices and other commodity prices. After more than one decade of absence, inflationary uncertainties made their great return, which make pressure on the chain domestic price via the pass through effect. The weak inflation observed up to 2007 was mainly due to the weakness of the oil prices related to the low costs of labor in the emerging countries. However, as soon as the prices of oil and those of the food prices have increased, the virtuous circle of the weak inflation of the nineties yields place to a resurgence of the inflation, which would destabilize the growth, in particular with the propagation of the rise of food and energy prices on the other prices categories of consumption. Initially, the energy prices intensified between 2003 to 2007 in particular during the first half of 2008. This rise of the oil prices is the result of an regular increase in demand since 2000, consequence of a strong economic growth, in particular of the industrialized nations of Asia. It’s also exacerbated by the depreciation of the dollar value compared to the euro.

With the resurgence of inflation throughout the world, the inflation-targeting regime is exposed a real test. The countries targeting inflation, which should to stabilize the inflation rates, did not act at the convenient time, for lack of effective instruments to prevent the uncertain effects of exogenous shocks. Moreover, as the central banks have found in front of the imported inflation, so to decide only using an adjustment of the interest rates will be without effects on the domestic prices. The behavior adopted by the majority of the central banks was to temporize concerning the rise of inflation without thinking that this could be expensive in terms of credibility. However, such behavior in relation to a persistent volatility of inflation could call into question the principle of the central bank independence by validating the argument of A. Posen (1993) and of B. McCallum (1996). Those economists argued that autonomy of the central bank is not a condition sufficient for the price stability. - The second period is explained by the fact why the inflationary risk, mentioned a long time by several central banks to adjust the interest rate to the rise, passes in the second plan in particular with the bursting of the financial crisis in 2008 and in a economic situation marked by the recession and the fall of the energy prices. The price of the barrel of oil oscillates around 40 US dollars, in January 2009, after having reached a peak of 147 dollars into July 11, 2008. In fact, the risks with the rise weighing on inflation attenuated. On the other hand, the intensification of the financial crisis increased the risks weighing on the growth, which justifies the decision of the principal central banks to reduce more their directing interest rates. The world has moved from rising inflation to an economic downturn. From now on, the preoccupation of the central banks, in the context of a major financial crisis, is to start again the growth and in the other hand to keep a solid anchoring of anticipations of inflation. This appears very crucial in period of economic and financial uncertainty. A central bank forward looking monetary policy should not omit a perfect knowledge of fundamental economic to anticipate the possible evolution of the economy. In fact, in front of the reality of financial system crisis, which the economic repercussions are disastrous, the central banks had recourse to concrete actions such as the financial support of the State, by circumventing

all forms of budgetary and monetary orthodoxy to answer the crisis. This established fact does not confirm the opinion of many economists, at least in the short run, who consider that a policy based on targets of inflation is a policy of stabilization of the production. Indeed, it’s important to underline that the mission of price stability so preached by the central banks should not take primacy over that of financial stability. These two missions should interfere more for a total stability of the economy. Moreover, the stability of the financial system it is conceived as being one of principal prerequisite for implementing the inflation target ? Therefore, it is difficult to know with certainty the advantages of implementing the inflation targeting strategy in a context marked by uncertainties and recurring shocks of unforeseen supply and demand, and which could lead to an economic recession and an erosion of the credibility of the monetary policy. Finally, the implementation of the inflation targeting strategy as well in the industrialised countries as in the developing countries shows that its application is not without difficulty. It is a question of distinguishing two major determinants from inflation. Initially the volatility of the exchange rates combined with the unpredictability of the energy prices on the world market generate imported inflation. Secondly, the phenomenon of uncertainties, which increases the risks in the financial markets, reduces the investment and consequently the growth. (*) Written in January 2008, this article is one of the works performed by the author on monetary economics and inflation targeting. For more information cf, kamal. El-Oualy “The inflation targeting in emerging countries: Its implementation opportunities in Morocco”. Doctorate in Economics Sciences with High Honours from the Faculty of Economics Sciences of Fez, May 2008.