COMMENT Inflation targeting is now facing its greatest challenge from a series of fundamental shocks. High energy and other commodity prices have led to inflation rates well above the inflation target – nearly 5 per cent in the UK versus the 2 per cent inflation target, for example – at the same time that the financial markets are reeling from the worst financial crisis since the Great Depression. Some critics of inflation targeting have argued that under the present circumstances, such targeting should be abandoned.
Is inflation targeting an idea that worked well in the past, but cannot cope with the stress of the present environment? How can monetary policy respond to the negative shock to the economy from the financial crisis, when inflation targeting requires a commitment to reduce inflation back to its target? Would the need to hit the inflation target not require tighter monetary policy that will just kick the economy when it is down?
