Inflation Targeting Frameworks

India will complete a decade of inflation targeting (IT) in 2026. India’s IT regime has been largely successful, with CPI remaining within the target band ~71% of the times. CPI breached the target only during crisis events such as Covid-19 and the Russia-Ukraine war. The current framework is under review and RBI is preparing a discussion paper. In this report, we review the evolution of IT regimes in 10 EMs viz. Brazil, Chile, Colombia, Indonesia, Mexico, Philippines, Russia, South Africa, Thailand and Turkey. The cross-country comparison reveals: • India was a late entrant to the IT club. Most countries in the sample adopted IT over 20 years ago • Seven countries lowered their midpoint inflation targets as IT frameworks matured • There is no clear pattern when it comes to tolerance bands. Two countries each widened and narrowed the bands, four countries kept the bands unchanged, and two countries do not have bands • India’s FIT numerical targets (4%, ±2%) are amongst the highest in EMs. Experts estimate India’s trend inflation at ~4%, justifying the midpoint. Also, large forecast errors and vulnerability to shocks warrant wide tolerance bands • There doesn’t appear to be a link between numerical targets and share of food in CPI • No country targets core inflation. Thailand targeted core CPI until 2015 before shifting to headline • No country in our sample has an escape clause allowing the central bank to shelve inflation targets temporarily during exceptional circumstances • Only 3 countries have external members; 3 countries do not publish minutes, and in 7 countries the inflation target is set jointly by the government and central bank • Eight EMs have at least one parliamentary hearing on IT; 4 require open letters if targets are missed We also review recommendations given by the RBI in 2021 to improve the framework and compare them with the above-mentioned EMs. Notable RBI recommendations are: • Reduce the shut period to 3 days after policy for better communication; release meeting minutes within a week; and meeting transcripts with a lag of 5-7 years • Stagger onboarding of external members. Nine countries in our sample follow this practice • Provide forward guidance on interest rates. Currently no EM gives explicit forward guidance • Modify the definition of failure to CPI remaining outside the band for four consecutive quarters Hence, it is likely that the current numerical targets (midpoint 4%, tolerance band ±2%) will be maintained for the third term of inflation targeting during April 2026 to March 2031. Although international experience shows that midpoints are lowered and tolerance bands are narrowed as IT frameworks mature, in India’s case a sustained decline in trend inflation and lower forecast errors are prerequisites for this to happen. Some measures to improve the transparency, accountability and effectiveness of IT could be considered by the expert committee on the IT framework review.

Rather than targeting interest rates, the Monetary Authority of Singapore manages the Singapore dollar’s exchange rate against a trade-weighted basket of currencies. The MAS adjusts the pace of appreciation or depreciation to achieve its inflation goals, essentially conducting inflation targeting but with the exchange rate as the instrument. It’s a novel approach that has delivered impressive results: since the 1980s, Singapore has enjoyed low inflation, high growth, and remarkable resilience to shocks. Against this backdrop, a new study by the Inter-American Development Bank provides a rigorous economic rationale for Singapore’s framework, at least for economies that are highly open to trade. Using macroeconomic models calibrated to data from Singapore and Chile, the study finds that exchange rate management can provide significant welfare gains — equivalent to a 1.5 per cent permanent increase in consumption — for extremely open economies like Singapore, where exports and imports total nearly three times GDP. The rationale is straightforward. In a very open economy, exchange rate volatility has an outsized impact on inflation, output and living standards. By adjusting the pace of currency appreciation or depreciation, monetary authorities can tame this volatility and deliver greater macroeconomic stability.

📢 Inflation Forecast Targeting Revisited It's great to see that our paper titled “Inflation Forecast Targeting Revisited,” co-authored with Zeno Enders and Gernot Müller, is now published as a CEPR - Centre for Economic Policy Research discussion paper. Summary of the paper: The recent surge in inflation caught policymakers off guard in both the euro area and the United States. Relying on inflation forecast targeting, they were slow to respond, believing the inflationary pressures to be temporary, as projections indicated that inflation would return to target over the medium term. Against this backdrop, we revisit the practice of inflation forecast targeting. We evaluate the ECB’s inflation projections: they are unbiased and efficient but contain little information at forecast horizons beyond three quarters. In a New Keynesian model with transmission lags, inflation forecast targeting is indeed effective in stabilizing inflation—provided there is no forward-looking behavior in the private sector—though the information content of forecasts is unrealistically high. In the presence of forward-looking behavior, the information content of the forecasts declines because monetary policy becomes more effective in meeting its target; however, inflation is best stabilized by targeting current inflation. Link to the paper: https://lnkd.in/eNPt9v6J #inflation #inflationtargeting #monetarypolicy #forecast #projections #ECB

🔔The IMF recently published a selected issues report on South Africa that includes analysis of the macroeconomic effects of a potential change in South Africa's inflation target. It finds: ➡️moderate short term disinflation costs: a sacrifice ratio of 0.6 (output loss per percent inflation decline). See the post for links to our discussion of uncertainties around sacrifice ratio estimates. ➡️ if the SARB's plans to reduce the target are credible, these costs are much lower. As we have shown, inflation-expectations in South Africa are backward-looking, which means that if takes time for firms and households to believe that SARB will be able to permanently reduce inflation (our expectation), then the sacrifice ratio would be 1.2 instead. ➡️ if fiscal and monetary policy are coordinated such that there is fiscal consolidation that brings down public debt it would reduce the sacrifice ratio overall. The IMF acknowledge that fiscal consolidation would, however, add to the short-term output costs of disinflating. ➡️ achieving a lower target over the long term would reduce borrowing costs in the economy and ultimately support long run growth. However, if inflation expectations only gradually adjust towards a lower target (again our base case) then economic growth remains lower that otherwise for almost 5 years. ✅Overall, the IMF's message is in line with our earlier paper on Gaps in the South African Inflation Targeting Debate: that clear communication of any plans to revise the target and buy in from government will be key to successfully lowering the target. But achieving buy in is not a given - as we argued (see post for links) - we have not seen evidence of this yet and if anything, there is a risk that the fiscal stance and government policy will counteract SARB's plans. This would see raise borrowing costs rise and impose very large adjustment costs on the private sector. Like our paper, the IMF emphasise that the SARB must 'ensure transparent and consistent communication with the public and markets to guide expectations'. For those interested, we go into a lot more detail about what practical steps the SARB should take to ensure a successful target reform process. https://lnkd.in/ddCzzUZA