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The government decides the inflation target for the rate-setting panel for a period of five years. So far, the headline consumer price index inflation target has been kept at 4 percent with a tolerance band of two percentage points on either side.
Benefits and drawbacks of Inflation Targeting?
Like all monetary policy instruments, inflation targeting comes with its fair share of benefits and drawbacks, they are the following:
Benefits
Inflation targeting allows monetary policy to “focus on domestic considerations and to respond to shocks to the domestic economy”, which is not possible under a fixed-exchange-rate system.
Transparency is another key benefit of inflation targeting. Central banks in developed countries that have successfully implemented inflation targeting tend to “maintain regular channels of communication with the public”.
An explicit numerical inflation target increases a central bank’s accountability, and thus it is less likely that the central bank falls prey to the time-inconsistency trap. This accountability is especially significant because even countries with weak institutions can build public support for an independent central bank.
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