Inflation is a general increase in prices. To measure its level, an indicator of the change in the cost index relative to the base period is used.
Classification
Inflation is of two types. The first is due to increased demand for goods. Accordingly, it is called demand inflation. In this case, the consumer is willing to pay more for specific products. At the same time, the economic system can strive for a certain point that is outside of production capabilities. Thus, enterprises, depending on circumstances, either increase the price of a product or increase its output. Supply inflation occurs with relatively constant demand. Product prices increase in this case due to rising costs (increases the cost of products). Since enterprises cannot sell products at a loss to themselves, they are forced to increase their price. In accordance with the law of supply and demand, in the event of an increase in value, the number of units sold is reduced. If the government of the country does not take any adequate measures, then the economy will begin to decline.
Transition to inflation targeting
In many developed countries, the general rise in prices is an urgent socio-economic problem. Inflation is not only an increase in the cost of production. It leads to the depreciation of savings, the outflow of capital in real estate, precious metals and foreign assets, and a decrease in investment attractiveness. This, in turn, slows down economic growth, complicates long-term planning, and increases tension in society. Currently, many states use exchange rates and monetary aggregates as intermediate objectives of the financial and credit program. But in the nineties, many countries moved away from this tradition. Some experts believe that the financial and credit program of some states can be characterized to some extent as inflation targeting. So, for example, the famous economist J. Taylor believes that in the USA it relies on the empirical position of this approach. In accordance with this rule, the reserve federal system periodically adjusts the interest rate on funds. So it reacts to deviations of domestic output from potential output, and inflation - from the forecast indicator. Some countries specifically choose this approach. Undoubtedly, there are pros and cons of inflation targeting. But for such states, achieving a stable price level acts as the most important factor ensuring economic growth.
Inflation targeting policy
As practice shows, all attempts to achieve other goals of economic sustainability (production growth and high employment) contradict the principles of price stability. In a situation where a developed country is threatened by inflation, central banks, as a rule, begin to raise interest rates using inflation targeting. This, of course, causes a lot of dissatisfaction, especially from entities involved in the real sector of the economy. This approach, however, helps prevent conflicts of interest. This is due to the fact that the main goal of the financial and credit program is not the stimulation of a high rate of employment or industrial growth, but the planned "formation" of inflation. In addition, on the basis of this approach, adequate response measures can be taken even before the onset of the crisis.
The essence of the method
How does inflation targeting work? The Central Bank predicts the expected dynamics of price growth and compares it with the target indicators, which it is desirable to achieve. The resulting difference indicates the necessary extent of adjustment of the financial and credit program. As a result, a planned inflation level is established. The authorities at the same time use all means to achieve this indicator. States that use this approach believe that it contributes to the effectiveness of monetary policy in comparison with standard practices.
Initial requirements
There are two conditions that must be met in order to achieve inflation targeting. It:
- A sufficient degree of independence of the Central Bank from the government. A financial institution should be free to choose the tools with which it is supposed to reach the target level.
- The refusal of the authorities to target other economic indicators. These include, but are not limited to, salaries, exchange rates, or employment levels.
Explanation
To fulfill the first condition, one should abandon "fiscal dominance". This means that the fiscal system should not have any effect on the financial and credit system. When refusing fiscal dominance, an extremely low or zero level of government borrowing from the Central Bank is assumed, as well as a sufficient development of the domestic money market. The latter is necessary to absorb additional emissions of government obligations. In addition, the state should have a large revenue base. While maintaining fiscal dominance, the tax system will stimulate inflationary pressures. This, in turn, will reduce the effectiveness of the financial and credit program. As for the second condition, if a country pursues a policy of a fixed exchange rate, with high mobility of international capital, it will not be able to simultaneously apply inflation targeting. This affects market participants who will not know which of several goals the government will give preference to if the situation worsens. For example, if there is a chance of a stable exchange rate, the Central Bank will have to choose: continue to maintain a fixed rate and thus abandon the inflation target, or maintain the planned level, but sacrifice the exchange rate.
Action chart
The main activities that are necessary to carry out effective inflation targeting are:
- Development of a forecasting methodology or model.
- Establishing quantitative inflation indicators for the coming period.
- Assurance of market participants that the goals set are more relevant than the rest.
- Selection of suitable monetary instruments. With its help, inflation will decrease to the target level.
- Creation of institutional and technical prerequisites for forecasting and modeling of internal price increases.
- Determining the lag between the moment of introduction of monetary instruments and the time of its impact on the inflation rate.
- The study of the degree of effectiveness of individual tools.
The definition of the target also includes:
- Choosing the type of price index.
- Formation of tasks in terms of inflation rate or price level.
- Calculation of the dynamics of the upcoming increase.
- Statement of the goal as a range of fluctuations or a point value.
- The reservation of probable deviations from target indicators or refusal of a reference point in case of special circumstances.
The situation in the Russian Federation
Today, experts believe that the Central Bank adheres to a “catch-up strategy”, within the framework of which Russia’s transition to inflation targeting is planned. So, in particular, in the draft Guidelines for the financial and credit program for 2013-2015. it was pointed out that the continuity of the principles applied would be maintained over a three-year period. By 2015, it was planned to establish an inflation targeting regime in the country. The project also indicated that, thanks to a set of measures aimed at improving the system of instruments, increasing the flexibility of the ruble exchange rate, manageability by current interest rates was achieved. However, the mechanisms that the Central Bank uses are not enough to ensure stability in the economy.
Problems
Inflation targeting in Russia is hampered by a number of significant circumstances. As usual measures with this approach, measures are taken to reduce budget expenditures, tighten financial discipline, and reduce the volume of loans for commercial banks. As a result, negative phenomena occur. In particular, lending to banks in the industrial sector is declining, liquidity, consumer and investment demand are falling, and income growth of citizens is halting. The inflation rate is determined by indicators whose dynamics is almost impossible to predict. Such monetary variables include the monopolization of domestic markets, the imbalance in global trading floors, especially in the energy market. Slowing inflationary rates by lowering money supply may contribute to a further drop in liquidity. This, in turn, will cause significant problems in the banking sector. Since inflation in the Russian Federation is mainly imported, an increase in interest rates will not be able to significantly affect the cost of hydrocarbons. As long as the country does not take measures aimed at limiting the impact of world prices on domestic prices, the latter will increase after the former. The traditional approach for targeting is considered to be an increase in interest rates of the Central Bank. This measure can help reduce aggregate demand. It, in turn, will slow down the economy and limit the increase in the cost of a number of services and goods, especially non-traded ones. However, these actions alone are not able to reduce inflation to the planned levels.
Possible solutions
In the absence of a targeted structural and investment program, technological changes in the domestic economy are estimated by experts as regressive. They are expressed, according to experts, in a fairly rapid degradation of the structure of the economic system. The most serious regression affected modern industries, which made a "rollback" to 15-20 years ago. This means that targeting should primarily be aimed not at inflation, but at economic growth. In the real sector there is a strong depreciation of fixed assets. To speed up their updates will require huge investments. It is impossible to find capital in the own funds of enterprises. In today's situation, production cannot do without borrowing.