Question

Explain briefly the need for establishing credibility of a central bank. In particular, how does credibility help resolve the problem of ‘time inconsistency”. What institutional features are included in the Reserve Bank of New Zealand (RBNZ) Act 1989 to help maintain the credibility of monetary policy. What is the most crucial part of the ‘inflation targeting regime’ introduced by New Zealand in 1990 and copied by many countries around the world? Exactly how is this operationalized? How might the Federal Reserve’s introduction of “average inflation targeting” in 2020 help (or not) the US economy recover from the COVID-19 shock? In answering this question first explain what average inflation targeting is, how it is different from inflation targeting, and how it might affect inflation expectations. What are the problems regarding the credibility of average inflation targeting?

Answer 1

(1) Credibility of central bank is essential for economics.If people believe that the central bank will do what it says,then the bank is credible.This bank assure for bussiness, governments and stakeholders to have sense of certainty about future.Central bank credible has an inflation target more than non credible bank to achieve target.Decision maker's preference change over time,so the preference become inconsistent.This is called time inconsistency.As the result of credibility there is less ability and incentive for policymakers to deviate discretionry policy,it could increase output or inflation rate.So can be solve time inconsistecy.

(2) Reserve bank of New Zealand act says about the formulating and implementing of monetary policy.It will promot the efficient financial system and carrying other functions set out in the act.Monetary policy help to maintaining the stability and general level of prices.It will help to reducing the bussiness cycles and inflation variability.This act help to increasing the accountability and improving the transparency of policy actions.

(3) Infaltion targeting regime adjust the monetary policy to achieve the inflation rate.The crucial part is managing expected inflation rate when actual inflation deviate away from short run target.Inflation targeting regime is defined as adjusting monetary policy to achieve annual rate of inflation.In this long term economic growth is achieved by maintaining price stability, and it can be achieved by controlling inflation.It support economic growth and stability.

(4) The Fed will allow Inflation that aims for average 2% of time.So Fed funds rate will stay low for longer.It is called average inflation targeting.The difference of average inflation target is it have infinite time window for measuring inflation.In average inflation targeting price stability is important.In this inflation falls short of the target ,it increase the expectation of higher infaltion.If inflation exceed the target,it will reduce the inflation expectations.

During average inflation target federal have two challenges.First is,it has struggle to move inflation up to yhe 2% target level.Second is,it will struggle to deliver enough support to economy.So,it is not a very appealing alternative to the current economic system.

In this pandemic global economy, average inflation target help to get Maximum sustainable employment and price stability.Now,COVID-19 become an bigger problem.This average inflation target is shifted dramatically due to corona.Financial conditions are tightened.It increase the downside and upside risk.It lifting the rate of economic expansion.