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Regulating monetary policies

Feb 11, 2009

What Impact Does Inflation Targeting Have on Unemployment? a One Pager published by International Policy Centre for Inclusive Growth argues that inflation targeting does not exacerbate unemployment, but also has no impact on economic growth.

What Impact Does Inflation Targeting Have on Unemployment?

Author: Jose Angelo Divino
Publisher: International Policy Centre for Inclusive Growth, February 2009

This One Pager presents the findings of a recent empirical study of the impact of inflation targeting in a cross section of developing and emerging countries.

The reasons usually given to justify adoption of this policy regime are transparency and credibility in monetary policy, the reduction of uncertainty, and implementation of the institutional and economic reforms required by the new regime.

For developing and emerging countries, however, the economic benefits of inflation targeting are not yet well documented.

An inflation targeting regime uses the nominal interest rate as a policy instrument and aggregate demand is the transmission channel for monetary policy. On the real side of the economy, the consequences of this policy are twofold.

On the one hand, adoption of a monetary policy regime might have undesirable effects on the labour market. Inflation might be brought close to the target rate, but at the cost of higher unemployment and lower economic growth.

On the other hand, the price stability achieved might lessen uncertainty and create a favourable economic environment for consumption and investment. What does the empirical evidence reveal?

The author argues that empirical findings indicate that adoption of an inflation targeting regime did not exacerbate unemployment in developing and emerging countries.

On the contrary, adoption of the regime reduced the average unemployment rate and narrowed the output gap. Hence there is no apparent reason to condemn these countries for adopting an inflation targeting regime for their monetary policies.

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