Inflation Targeting

 “On Money and Banking”
Simply put, inflation targeting is a monetary policy framework that deals primarily with price stability as its primary goal. This is accomplished through the establishment of a specific inflation rate that a country’s central bank would strive to meet over a set period of time. By carefully orchestrating interest rates and other financial instruments in accordance with the intricacies of the market, these targets inflation rates are rendered more feasible and realistic.
Perhaps the biggest advantage of utilizing inflation targeting lies in its ability to be easily understood by the public. It focuses on the long term, and theoretically leads to greater transparency as its easily quantifiable structure promotes greater accountability and responsibility within the central financial authority. Mishkin (2001) argues that “it is devised in such a way that its viability is not completely predicated on a stable relationship between money and inflation” (p. 2) – instead it relies on comprehensive economic information to determine the instruments to be utilized. A properly implemented scheme brings more credibility and encourages public support for the central banking authority because of its highly transparent nature.
On the flipside, some pundits argue that one of its biggest disadvantages is that it renders any form of direct control over inflation very difficult to achieve, largely in part to its rigid structure leaning too much towards the bottom line. Also, the strategy apparently leaves too much room for discretion, resulting in a hypothetical grey area in terms of process control and execution. Lastly, the unpredictable lag times between policy introduction and actual inflation rise may be too drawn out for the public to monitor effectively, and may even be forgotten altogether in the long run.
In theory, a principal agent problem centers on the difficulties that emanate from the lack of information each time a principal commissions an agent. According to Johnson (2005) “it is a difficult but extremely important and recurrent organizational design problem of how organizations can structure incentives so that people under contractual obligation would perform this obligation as promised” (n.p.) The primary dilemma lies in reconciling the different factors in the principal-agent dynamic en route to a synergistic and productive relationship.
Now how does this quandary directly correlate to bankers and politicians? The burning issue here is that because of previously existing relationships, politicians and regulators are not necessarily working for the “greater good” of society. Tighter and more stringent regulations keeping these indiscretions in check oftentimes prove futile. Why? It must be recalled that the essential idea of the principal-agent problem is that the “agents” need to perform to the utmost of their abilities– all for the benefit of their “principal”. Even if incentives and other initiatives are utilized to ensure this, as long as there is a significant presence of self-interest in the process the results are often tainted with bias and ineffectiveness. Politicians and regulators play a protracted, self-serving game, and in the end the “principality” of taxpayers/consumers are left holding the bag.
1. Mishkin, Frederick (2001) Inflation Targeting. Graduate School of Business, Columbia University. National Bureau of Economic Research.
2. Johnson, Paul (2005) A Glossary of Political Economy Terms. Department of Political Science, Auburn University.
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