Need a perfect paper? Place your first order and save 5% with this code:   SAVE5NOW

The Importance of Inflation Targeting in Emerging Market Countries


Inflation targeting requires monetary bodies to adopt a forward-looking attitude and take the preemptive action to fill the lags in policy decisions relating to their effect on output and prices. As Alan Greenspan put it, implicit within the confines of a monetary policy action refers to the expectations of how the future will unfold (Öztürk et al., 2014). Indeed, it has been proven that inflation-targeting central banks are executed through implementing inflation forecast targeting (Taylor, 2019). As opposed to reactionary measures, monetary policymakers are known to make decisions informed by conditional forecasts of future inflation, alternative interest paths, and the existing state of the economy. Organizations must develop a basic modeling framework because it permits policymakers to exercise their critical analysis in a structured manner that necessitates the arrival of informed decisions. Under this form of reasoning, economic models are identified as another tool that guides policy decisions under aspects of uncertainty about the state of the economy, its size, and the nature of the shocks that regularly hit it (Taylor, 2019). Inflation targeting is crucial because it yields more of the intended impacts as opposed to the actual impacts as it institutes commitment to price stability in the long run basis, medium targets are exposed for public announcement, monetary decisions are informed by information-inclusive strategy, high levels of transparency are exhibited in communication plans, and inflation targets are attained through increased transparency by the banks.


An Institutional Commitment to Price Stability

One significant element of inflation targeting is the public and institutional commitment to price stability as the monetary framework’s overriding goal. This institutional commitment has been incorporated within the statutes of many countries through the adjustment of their central bank legislator rules and regulations. These regulations are primarily prominent among the EMU nations, which have been fundamentally providing the central banks with the ability to regulate inflation (Martins & Skott, 2021). Besides this initiative, it is also important to note that laws matter less than the general public and the politician’s commitment to undertake price stability efforts. In this regard, a significant percentage of countries have had a history of poor support for the price stability objective. Because these laws can be easily overturned, more is needed to claim that developing laws would guarantee the public commitment to price stability.

The element of price stability within emerging nations’ economies can only be attained if monetary bodies are allowed some discretion to utilize monetary policy in coping with the shocks experienced within the domestic market. This form of flexibility regarding the utilization of monetary policy is required even more in emerging market countries because they are more prone to more significant shocks than developed economies (Martins & Skott, 2021). Research has indicated that inflation targeting regimes have built-in flexibility that permits them to achieve their inflation targets over a long-term basis hence earning it the description of “flexible inflation targeting.” Therefore, inflation targeting would only be successful in achieving price stability if it is supported by the public, the political process, and their respective leaders (Martins & Skott, 2021). This drives a concerted effort of the public towards achieving this noble goal in running economic activities.

Price stability efforts were highly successful in Germany under the Bundesbank regulation that saw the government of day engaging fully in purchasing trade bills. This move was fundamental for the economy’s health because it offered a reasonable avenue for providing long-term central bank money (Coibion et al., 2020). This led to a substantial decrease in the quantitative significance of rediscount credit. In normal market conditions, the subsidy aspect associated with the discount rate calls for the quota system to exhibit rediscount volume (Coibion et al., 2020). Over the past few years, Bundesbank has successfully reduced the special financing facilities that existed alongside regular rediscount quotas. Implementing these monetary regulations under the broad Bundesbank regulatory framework has been identified to yield numerous benefits for emerging markets, such as the promotion of exports, the growth of small and medium-sized firms, and increased forms of intranational trade.

Exposure of Medium-term Targets to Public Announcement

Another essential feature of inflation targeting is the transparency of the policy regarding public scrutiny and accountability. The success of a monetary policy is pegged on its level of pre-announcement to the public as well as the well-defined inflation targets that are significant for building public support of independent central banks, even in the absence of rigidly defined standards of performance evaluation or punishment. Many industrialized nations began engaging in monetary targets in the mid-70s by embracing these three measures. First, these bodies relied heavily on information deployed by a monetary aggregate for the execution of the monetary policy (Budianto et al., 2020). The other two measures included publicly announcing the medium-term targets relating to monetary aggregates as a strategy to avoid businesses being caught unawares and supporting high levels of accountability involving systematic deviations from the monetary targets.

Public announcement of medium-term targets has been established to yield various benefits as far as business operations of an economy are concerned. The first benefit is that since the monetary aggregates are reported within short timeframes, they are more likely to send essential signals to both the public and markets regarding initiatives taken by the policymakers (Budianto et al., 2020). This information is essential as it enables society to keep inflation under control. Furthermore, public announcements generate signals responsible for fixing inflation expectations (Coibion et al., 2020). This is because the public announcement provides the factors influencing the current medium-term targets and future inflation projections. Lastly, these forms of announcement trigger immediate accountability about monetary policy that aids in keeping inflation at manageable levels.

However, inflation targeting has been identified to fail in emerging markets for various reasons increasingly. These reasons are similar to those that caused inflation targeting to fail in U.S., Canada, and United Kingdom. Inflation targeting is more straightforward to implement in industrial countries than in developing countries. This is because developing nations have relatively high inflation rates, making it hard for future projections to be made more accurately (Krušković, 2022). The high rates of inflation increase the likelihood of inflation targets being inaccurate. The other reason is that the degree of pass-through from exchange rate changes to prices is excessively higher in developing countries leading to considerable inflation inertia. The other reason it is hard for inflation targeting to be successful in developing nations is that these nations have significant portions of assets and liabilities that may yield severe effects on inflation in the incidence of significant exchange rate movements (Krušković, 2022). Lastly, central dependency is more of a statutory factor in many developing nations, which means that most decisions are still governed by the desire to finance a fiscal deficit. This necessitates some persistence of fiscal dominance.

Utilization of Information-inclusive Strategy in Making Monetary-Policy Decisions

The information-inclusive strategy is used in making monetary-policy decisions concerning implementing inflation targeting in emerging market countries. New Zealand was the first to embrace inflation targeting by adopting an information-inclusive strategy. This move saw the country record a reduced inflation rate from 17% to 5% (Bernanke et al., 2018). This achievement then compelled the New Zealand government to pass the New Reserve Act through the inclusive strategy that not only fostered the central bank’s independence but also enabled the country to grow from the least independent to the most independent country among the list of industrialized countries. Canada was the second country that adopted the inflation targeting mechanism by utilizing an information-inclusive strategy (Bernanke et al., 2018). The government and the Central Bank of Canada work in unison regarding implementing the inflation-targeting model. However, in the incidence of a disagreement, the minister of Finance would issue a directive that the bank must follow.

New Zealand and Canada introduced targets that were significant in helping with disinflation. The achievement of these countries in taming the relatively high rates of inflation necessitated the other countries to adopt these policies, yet inflation in most of these nations was already low. The countries that emulated the inflation policies that New Zealand and Canada initially implemented were the United Kingdom, Finland, Sweden, Australia, and Spain (Bernanke et al., 2018). Despite the achievements realized by New Zealand and Canada, these seven countries were identified to have shared a relatively poor record of fighting inflation over the 30-year window in their relationship with Germany, Japan, Switzerland, and the United States (Martins & Skott, 2021). Market participants concluded that these seven states lacked the credibility of monetary policy. This was because the inflation rate was the primary monetary policy prioritized above other objectives, such as the exchange rate or employment rate.

Despite the milestones realized, it is still too early to declare that the inflation-targeting approach has successfully delivered lower inflation. This is because many industrial states are yet to adopt the inflation-targeting model. In 1992, the countries that embraced the inflation-targeting model recorded a decline in their inflation rates more than their industrial nation counterparts. However, they have now maintained a constant rate of inflation that is comparable to major industrial economies (Martins & Skott, 2021). Even though inflation has fallen in countries that embraced the inflation-targeting strategy, there has been a systematic increase in unemployment. Only New Zealand recorded a decline in unemployment although the unemployment rates remained significantly above the level recorded during the second half of the 1980s (Martins & Skott, 2021). Evaluation of unemployment in the inflation-targeting nations with that being experienced in major industrial nations indicates that the average unemployment rate increased significantly during the early 90s within inflation-targeting countries but has reduced to the level of major industrial countries since 1994.

Increased Transparency through Communication of Plans

Increased transparency between the federal government and the central banks was exhibited in the case of the Brazilian nation. The president of Brazil issued a decree that required financial institutions to implement inflation targeting regime in their operations. This decree required Banco Central do Brasil to submit an open letter to the ministry of Finance explaining the reasons behind the breach of the inflation target. Furthermore, he was also required to present the appropriate steps that would be taken to get inflation down to its usual rate. The large overshoot of inflation targets had kept the credibility of the central bank on the line but Banco Central do Brasil rose to the occasion and performed exemplary well. In its explanation, the central bank enumerated to the federal government the reasons why the exchange rate had overshot together with making explicit estimates of the size of the shocks as well as their persistence. The regulated-price shock was estimated to be 1.7% while the estimated inertia from the past chocks was at 4.5% which represented 2/3 of what was anticipated (Taylor, 2019).

There were two other figures that the Central Bank of Brazil added to its findings. First, the bank announced a target of 4% to get an adjusted inflation target for 2003 of 8.5%. This target was then communicated through public announcement in an open letter that was sent to the minister of Finance in January of the same year. The letter enumerated that for the economy to get to the non-adjusted target of 4% within a short timeframe, this would mean incurring high losses on output (Bernanke et al., 2018). To validate this scenario further, the attempt to attain an inflation rate of 6.5% in 2003 would involve the country’s GDP declining by 1.6%. Also, in the incidence that country was set on the path of achieving a lower target of 4%, the GDP would decline further by 7.3% (Bernanke et al., 2018).

Accountability from the Banks in Relation to Attaining Inflation Targets

In the financial sector, accountability has a slightly different meaning because it denotes that the central bank would be required to pay high charges in the incidence that engages itself in discretionary policy that results in high inflation. Guillermo, in his argument, is correct because inflation targeting cannot be treated as a one-size-fits-all remedy. This regime can only be able to constrain this existing discretion because it has to be supported by the public and the political process. The accountability from banks should this be exhibited by their unending desire to direct public debate about inflation targeting towards the direction that supports a monetary policy focus on long-run goals as price stability; the same way this has been recorded in many inflation targeting nations. These benefits can only be realized if the banks are increasingly accountable for the actions they take and are always willing to communicate these actions to only the critical players in emerging markets but also the consumers of these markets. As such, excellent communication would be deemed insufficient if the political figures are not in strong support of the independency of the central bank in relation to inflation control.

Actual Impacts of Inflation Targeting Regime

  • Fluctuations in Exchange Rate

Liability dollarization denotes that depreciations are exceedingly dangerous because they trigger financial crisis that serves to increase the debt ceiling of a nation. A significant population of nations have their debts denominated in foreign currency in such a way that when the currency depreciates, the debt burden of domestic firms increases. Additionally, since the assets are typically denominated in domestic currency and hence do not increase in value, there is a substantial reduction in these companies’ net worth. The deterioration in in balance sheets then increases adverse selection and moral hazard problems that leads to financial instability and a sharp decline in investment as well as economic activity. This mechanism is the reason behind the currency crises in Chile in 1982, Mexico in 1994-95, Ecuador in 1999, East Asia in 1997, and Argentina from 2001-2002 (Taylor, 2019). As a move to prevent sharp depreciations in the currencies of these nations that may ultimately destroy the balance sheets and trigger a financial crisis, central banks have been compelled to move with speed in smoothening the exchange rate fluctuations. This move is also dangerous as it may result in emerging markets realizing the possibility of “fear of floating.”

  • The Downside of Focusing on Limiting Exchange Rate Movements

The first challenge of putting too much focus on limiting exchange rate movements is that it runs the risk of putting too much weight on the exchange rate as opposed to the inflation target. This has been identified as a recent problem facing Hungary that has had the exchange rate target as part of its inflation targeting regime. During Hungarian adoption of inflation targeting back in July 2001, the country retained an exchange rate band of ±15 percent (Powell, 2022). At that time, the country was pursuing two nominal objectives; a move that would lead the company to offer preference to one objective over the second objective. This scenario was identified to make monetary policy less transparent and prevent the achievement of the inflation target. Even this is what occurred in Hungary, January 2003 saw the appreciation of the upper end of the band that resulted in the country recording a sharp acceleration of capital inflows that compelled the National Bank of Hungary to respond with reducing interest rates by 2 percentage points (Powell, 2022).

The other problem is that inflation targeting reduces flexibility based on the nature of the shock that results in exchange rate movement. Therefore, different monetary policy responses are required based on the nature of the shock being experienced. In the incidence that the domestic currency depreciates courtesy of the pure portfolio shock, inflation within the country may increase and this can only be corrected with the tightening of the monetary policy together with the raising of interest rates (Powell, 2022). For emerging market nations that experience liability dollarization, tightening the monetary policy to prevent the assets from recording a sharp depreciation is even more necessary to avoid incidences of financial instability (Powell, 2022). On the contrary, in the incidence that exchange rate depreciation happens in the incidence that real shocks have occurred, the impact is less likely to be inflationary, thus warranting the adoption of various monetary policy responses.

The mistakes that the Chilean Central Bank made in 1998 exhibited the seriousness of the second problem enumerated above. The inflation targeting regime that has been emulated by Chile also entailed a focus on limiting the exchange rate fluctuations by implementing an exchange rate band with a crawling peg that delayed the domestic inflation (Powell, 2022). As opposed to lessening the terms of the monetary policy in the face of negative terms-of-trade shock, the central bank in Chile opted to increase the interest rates sharply and even narrowed its exchange rate band. These decisions were identified as one of the greatest mistakes to be omitted by the central bank in Chile because it plugged the economy to a recession for the first time since the 90s (Powell, 2022). After heavy criticism from scholars and the public, the central bank in 1999 reversed this course by easily monetary policy through the lowering of the interest rates and allowing the peso to decline in value, leading to a further revision in 2000 that now focused entirely on exchange rates.


In a nutshell, inflation targeting is an important regime in emerging market countries if only the financial bodies adhere to the five elements that have been discussed in this paper. The first element is that the emerging market economies should exhibit an institutional commitment to price stability. This required unified efforts of the Central Banks of respective countries and their federal governments. The success of price stability in relation to inflation targeting can only be obtained through concerted efforts by the public together with all the political leaders of the nation. Furthermore, making public announcements of medium-term targets of inflation yields various benefits, such as the probability of sending important signals to both the public and the markets with regards to initiatives by the policymakers, fixing inflation expectations, and being accountable for monetary policies. Furthermore, information-inclusive strategy as the other element of the inflation targeting ensures that the Central Bank and the Federal government are working in unison with regards to making monetary policy decisions. Lastly, increased transparency through the communication of plans and increased accountability on the part of banks guarantees success in the implementation of the inflation targeting regime in emerging market countries.


Bernanke, B. S., Laubach, T., Mishkin, F. S., & Posen, A. S. (2018). Inflation targeting. In Inflation Targeting. Princeton University Press.

Budianto, F., Nakata, T., & Schmidt, S. (2020). Average inflation targeting and the interest rate lower bound.

Coibion, O., Gorodnichenko, Y., Knotek II, E. S., & Schoenle, R. (2020). Average inflation targeting and household expectations (No. w27836). National Bureau of Economic Research.

Krušković, B. D. (2022). Central bank intervention in the inflation targeting. Journal of Central Banking Theory and Practice11(1), 67-85.

Martins, G. K., & Skott, P. (2021). Sources of inflation and the effects of balanced budgets and inflation targeting in developing economies. Industrial and Corporate Change30(2), 409-444.

Öztürk, S., Sözdemir, A., & Ülger, Ö. (2014). The effects of inflation targeting strategy on the growth performance of developed and developing countries: Evaluation of pre and post stages of the global financial crisis. Procedia-Social and Behavioral Sciences109, 57-64.

Powell, J. (2022). “Supply of Money,” Unit 2: Demand for and Supply of Money, 19 December.

Powell, J. (2022). “Supply of Money,” Unit 2: Demand for and Supply of Money, 19 December.

Powell, J. (2022). “The Exchange Rate,” Unit 5: International Finance and Monetary Policy, 19 December.

Taylor, J. B. (2019). Inflation targeting in high inflation emerging economies: Lessons about rules and instruments. Journal of Applied Economics22(1), 103-116.


Don't have time to write this essay on your own?
Use our essay writing service and save your time. We guarantee high quality, on-time delivery and 100% confidentiality. All our papers are written from scratch according to your instructions and are plagiarism free.
Place an order

Cite This Work

To export a reference to this article please select a referencing style below:

Copy to clipboard
Copy to clipboard
Copy to clipboard
Copy to clipboard
Copy to clipboard
Copy to clipboard
Copy to clipboard
Copy to clipboard
Need a plagiarism free essay written by an educator?
Order it today

Popular Essay Topics