Home Pros and Cons 6 Advantages and Disadvantages of Inflation Targeting

6 Advantages and Disadvantages of Inflation Targeting

Most countries in the world have institutionalized inflation targeting. The central bank is primarily responsible to keep an unfailing focus on inflation. The executive or the elected government has a select committee in most countries keeping a daily tab on fluctuations inflation rates. The legislative, parliamentarians or senators also have policies in the pipeline or as backups to counter uncontrolled inflation. The practice has been in place for almost fifty years now where countries want to keep a check on inflation. If unchecked, inflation can wreak havoc on the economy and the future of the country.

Two measures are used in inflation targeting. One is consumer price index or CPI and the other is wholesale price index or WPI. Both indices are tracked and studied every day. Over the years, the major stock exchanges of the worlds, investors, traders and anyone who runs a business along with every aware citizen have been watchful of their local, regional and national inflation rates. Every major central bank in the world announces publicly the rate which they are trying to cap the inflation for a given period of time. Political parties and elected representatives also take public stands on whether the rate is achievable or if it is impractical. Inflation targeting has its benefits and there are challenges as a result. Here are the inflation targeting advantages and disadvantages.

List of Advantages of Inflation Targeting

1. Balancing Predictability and Expectations
Inflation targeting instills predictability. If one was to take a broader view of the world, then situations will appear to be relatively predictable. The moment one delves into the natural upheavals in microenvironments, then everything can turn topsy-turvy in no time. People lose jobs every day, businesses open and many shut every week. Companies make profits and organizations go bankrupt every month. With no check on inflation, people and organizations would not know what to expect. Employees will demand higher wages. Companies will not know what kind of costs they will have to bear. The agricultural sector will be in losses. The markets will be on an uncertain ride. The whole economy may look clueless and unorganized. With inflation targeting, some sense of normalcy, calm and predictability can be attained.

2. Preventing Bubbles and Fuelling Sustainable Growth
Inflation targeting can help avert disasters. One sector that plays a dominant role in the economy changing its policies can have an impact on the whole nation. The principal foundation of supply and demand works in all industries. If any sector is allowed a complete free hand at reviewing their production, selling prices and where they sell, then economic booms and busts will become a more frequent reality. Economies have periods of growth and there are lulls. But economies need to be monitored and controlled as much as possible to avoid unsubstantiated growth and then bursts of bubbles. Inflation is not a definitive indication of growth. Inflation if unchecked will lead to unsustainable growth and an inevitable recession.

3. Preventing Economic Collapse
Without inflation targeting, costs can skyrocket. What is affordable today may not be so tomorrow. Essentials may become unaffordable. Rising costs will hamper every life in the nation. Families would struggle to keep up with the rising costs and eventually there will be a complete economic chaos.

List of Disadvantages of Inflation Targeting

1. Unrealistic in Nature
Inflation targeting can become unrealistic. The very nature of an economy, especially the large ones, is that it takes a life of its own. The economy will react and be influenced by thousands of factors and it is not possible to always counter so many influencing elements. Hence, in an attempt to target a certain inflation rate or to keep it within a certain limit, central banks and governments take measures that prove to be wrong. Many a time in the past and in developed nations, governments and the central banks have not only failed to contain inflation but their attempts have led to more problems.

2. Against Development
Inflation targeting is panned by many as against development. Every time there has been a major developmental phase in any part of the world, inflation has followed. It is not entirely possible to keep the inflation in check at all times. Even today, there are places in every country where inflation targeting simply doesn’t work. It must be accepted that there are macroeconomic scenarios and microeconomic realties. Not always can the central banks micromanage. In fact, it is almost impossible to micromanage when economies are worth billions and in some cases trillions of dollars.

3. Side Effects
Inflation targeting can be hazardous for a country in the long term. It can render various industries to become uncompetitive. The governments may take up too much of the onus or the financial burden of keeping inflation under check. This can lead to higher fiscal deficits, poor welfare policies or stimulus packages and eventually the economy may cease to remain as free flowing as is needed.