Free Economics Dissertations - Introduction Inflation Can Be Considered As One Of The Big Macroeconomic
INTRODUCTION
Inflation can be considered as one of the big macroeconomic issues of our time. Inflation is generally considered to be undesirable, especially when it is unexpected. This is because it distorts the signals that are provided by the price system; it creates arbitrary redistribution from debtors to creditors; it creates incentives for speculative as opposed to productive investment activity and is usually costly to eliminate or predict.
Over the past fifteen years a growing number of central banks around the world have followed the lead of the Reserve Bank of New Zealand in adopting an inflation target as the objective of monetary policy. The United Kingdom was one of the early followers of this trend, introducing an inflation target in the aftermath of sterling’s exit from the Exchange Rate Mechanism (ERM), in September 1992. Since then Inflation has been low and remarkably stable, especially when viewed in the context of the UK’s past inflation performance. Moreover, that has come at the expense of other macroeconomic indicators, for growth has also been remarkably steady and close to trend, while unemployment has fallen almost continuously throughout the last decade, reaching levels last seen in the early 1970’s. Given the experience of the previous twenty years, very few people back in 1992 would have believed that the UK’s economic performance could have turned out so well.
It should be emphasised that this performance should not be solely attributed to the adoption of an inflation rate target. Major structural reforms to the labour market and were carried out first by the Conservatives under Margaret Thatcher and then consolidated in the 1990’s by both political parties. There is little doubt that many of those reforms have improved the workings of the real economy. But the adoption of an inflation target has. This has contributed to keeping inflation low and stable and helped provide the right sort of environment in which to reap the benefit of those reforms.
In this paper, we will look at the adoption of the inflation target regime in the UK, which was started in 1992 and the subsequent development of the regime. The delegation of operational responsibility for monetary policy control to the Bank of England in 1997 and the associated institutional framework surrounding this phenomenon is also discussed. Additionally, some aspects of the way the banks Monetary Policy Committee (MPC) formulates policy in relation to inflation targeting will be mentioned.
THE HISTORY OF MONETARY POLICY STRATEGIES
For the first part of post-war period, monetary policy was designated only a marginal role in the control of aggregate demand. In line with Keynesian principles, fiscal policy was seen as the primary tool of macroeconomic stabilisation, while interest rates were to be set low to encourage investment and credit controls employed to restrain consumer borrowing.
