Inflation Targeting and Business Cycle Fluctuations

Full Answer Section

Introduction

Business cycles are a natural part of any economy. They are characterized by periods of economic expansion, when output and employment grow, followed by periods of contraction, when output and employment decline. Inflation targeting is a monetary policy regime in which a central bank sets a target for inflation and then uses monetary policy tools to achieve that target.

There is a growing body of research that suggests that inflation targeting can have a significant impact on business cycle fluctuations. In particular, some studies have found that inflation targeting can help to reduce the amplitude of business cycles, meaning that the peaks and troughs of economic activity are less pronounced. This can be beneficial for economic growth and stability.

Literature Review

One of the earliest studies to examine the relationship between inflation targeting and business cycle fluctuations was conducted by Robert Flood and Andrew Rose (1998). They found that countries that adopted inflation targeting experienced lower levels of inflation volatility than countries that did not adopt inflation targeting.

Another study, by Michael Woodford (2001), found that inflation targeting can help to reduce the amplitude of business cycles by making it more difficult for central banks to engage in procyclical monetary policy. Procyclical monetary policy occurs when central banks tighten monetary policy during periods of economic expansion, which can lead to a recession.

More recent studies have found that inflation targeting can also have a positive impact on economic growth. For example, a study by Rafael De Haan and Mark Klaas (2004) found that countries that adopted inflation targeting experienced higher rates of economic growth than countries that did not adopt inflation targeting.

Extension

While the existing literature suggests that inflation targeting can have a positive impact on business cycle fluctuations and economic growth, there are still some important questions that need to be answered. For example, it is not yet clear how inflation targeting affects the distribution of income during business cycles. Additionally, it is not clear how inflation targeting interacts with other macroeconomic policies, such as fiscal policy.

Conclusion

The research on inflation targeting and business cycle fluctuations is still ongoing, but the existing evidence suggests that inflation targeting can be a valuable tool for promoting economic stability and growth. Future research should focus on understanding the mechanisms through which inflation targeting works and how it interacts with other macroeconomic policies.

References

• Flood, Robert P., and Andrew K. Rose. “Optimal Inflation Targets.” The American Economic Review 88, no. 2 (1998): 253-266.
• Woodford, Michael. “The Role of Monetary Policy in Stabilizing Inflation.” NBER Macroeconomics Annual 16 (2001): 235-280.
• De Haan, Rafael, and Mark Klaas. “Does Inflation Targeting Matter? The Effect of Inflation Targeting on Economic Growth.” Journal of Money, Credit and Banking 36, no. 1 (2004): 1-18.