Monetary Policy Challenges - Inflation Targeting Strategy and the Process of Euro Adoption

• Author: Adina Criste, Alina Georgeta Glod, Camelia Milea, Iulia Lupu
• Position: CCFM Victor Slavescu - CCFM Victor Slavescu - CCFM Victor Slavescu - CCFM Victor Slavescu
• Pages: 492-496

Monetary Policy Challenges - Inflation Targeting Strategy

and the Process of Euro Adoption

1Adina Criste, 2Alina Georgeta Glod, 3Camelia Milea, 4Iulia Lupu,

1CCFM Victor Slavescu, 2CCFM Victor Slavescu, 3CCFM Victor Slavescu, 4CCFM Victor Slavescu

Abstract. This paper is a review of some o f the challenges for the monetary authorities in countries which

adopted an inflation targeting strategy, and which are also intending to adopt Euro. Both the increasing

mobility of capit al flows and the preparations for entering ERM II are constraints for such a monetary

strategy. Since September 2008, the financial crisis, having burst into th e developed countries, has also

affected the Central and Eastern Europ e countries, and this phenomenon represents another challenge for the

monetary authorities.

Keywords: European integration, capital mobility, exchange rate flexibility, ERM II, financial crisis.

1 Introduction

The macroeconomics debate on the effectiveness or ineffectiveness of monetary policy along with

empirical evidence from many countries lead policy makers and economists to come to a general

consensus suggesting that monetary policy can exert some real effects on the economy, but only in

the short run. The same policy becomes ineffective to change the level of output in the long run and

has a negative effect on the central bank’s credibility and could lead to a loss of public confidence.

These empirical findings based on theoretical models lead many central banks to look for a credible

nominal anchor. Inflation could serve as one of these nominal anchors. The main objective of

inflation targeting is to achieve low and stable inflation in an economy. Other benefits of inflation

targeting include increased accountability of the central bank (or the monetary authority) and

transparency of their operating procedures. Hence, many emerging economies as well as some

industrialized countries have recently switched to ‘inflation targeting’ as their monetary policy

regime.

Early proposals of monetary systems targeting the price level or the inflation rate, rather than the

exchange rate, followed the general crisis of the gold standard after World War I. Interest in inflation

targeting schemes diminished during the Bretton Woods system (1944-1971), as they are normally

inconsistent with exchange rate pegs such as those prevailing during three decades after World War

II. New Zealand was the first country to adopt an inflation-targeting regime in 1990. Since then, many

countries have adopted this strategy including both industrialized countries (such as Australia,

Sweden, Switzerland, and the United Kingdom) and emerging economies (such as Brazil, Chile,

Columbia, Czech Republic, Iceland, Israel, Mexico, Peru, the Philippines, Poland, Hungary, Romania

and South Africa). Some discussion has also taken place in the Federal Reserve (the United States)

and the Bank of Japan to switch to an inflation-targeting regime. The European Central Bank (ECB)

already has a two-pillar system in place with inflation being one of the policy targets (along with

monetary targets).

Countries that have adopted the inflation targeting strategy aim at reducing inflation and inflation

expectations based on an independent national monetary policy, using a nominal anchor (low

inflation), as a rule of behavior to avoid or limit the problem of temporal inconsistencies.

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