| Since the early 1990s, an inflation targeting (IT) framework for monetary policy has been adopted by New Zealand, Canada, the United Kingdom, Finland, Sweden, Australia, and Spain (in chronological order). A number of developing countries, such as Chile, Israel, Mexico, Czech Public, Korea, Poland and Brazil, have adopted IT as a guide for monetary policy too. Because the experience of most of these countries with monetary targeting or a fixed exchange rate had proved unsatisfactory, this new framework for the conduct of monetary policy was required. Dr. Willem F. Duisenberg, President of the European Central Bank, described the targets of ECB as follows: ECB has chosen a strategy combining elements of monetary targeting, as practiced by the Deutsche Bundesbank, and elements of direct inflation targeting, as conducted by the Bank of England, for instance.The People's Bank of China Act has made it clear that the objective of monetary policy in China is to maintain price stability and then stimulate the growth of the economy. But from 1985 to 1999, the average change over previous year of CPI reaches 9.17%, and the standard error is as high as 7.43%. In 1997, deflation occurred in China and made the conduct of monetary policy even more difficult. But there isn't any mature theory for the monetary policy in transition economies, so we need to analyze the theory and practice of Inflation Targeting and take them as reference. This paper consists four parts.The first section is an introduction of Inflation Targeting. After a summary of IT frameworks, this section describes the prerequisites of, rationale for and key features of IT. And then this paper makes a specific contrast of the different IT frameworks adopted by the seven advanced countries.The second section analyzes the theoretic basis of IT. This part answers two questions: why more and more central banks consider price stability as the overriding objective for monetary policy and why different central banks select different targets while they all consider price stability as the most important goal for monetary policy.The third section examines the effects of IT in advanced countries. The economic performance to date of the new framework appears promising. Inflation has been brought down in all seven countries, the unemployment rate increased for a while but then declined steadily and the volatility in GDP growth has not increased. By examining the behavior of short-term interest rates that are used as policy levers by central banks and estimating the policy reaction functions, this section draws the conclusion that inflation targets have increased the credibility of central banks, and have led to a change in the response of monetary policy to near-term economic conditions.The fourth section discusses the possibility of wider application of IT to developing countries. It identifies two major prerequisites for adopting an IT framework in developing countries: (1) the ability to carry out a substantially independent monetary policy, especially one not constrained by fiscal considerations, and (2) freedom from commitment to another nominal anchor like the exchange rate. These fairly stringent technical and institutional requirements of IT cannot be met by many developing countries because seigniorage remains an important source of financing and/or because exchange rate is the main target of their monetary policy. But several Latin American countries, transition countries and Asian countries has met the prerequisites, and the practise of IT in Chile and Ireseal about one decade is successful. The last part of this section explores the lessons from IT for China. Althrough there is not necessarity and possibility for China to adopt IT in the near term, the experience about maintaining price stability from IT is useful for China's monetary policy. |
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