The Illusions of Inflation Targeting, With an Application to Ukraine

Nikolay Gertchev

doi:10.35297/qjae.010086

Abstract

This article reviews the analytical justification, the theoretical content, and the practical experience of inflation targeting, which has become the standard framework for monetary policy. It shows that due to the inflation-targeting literature’s neglect for the money demand as part of the monetary relation that drives price determination, it provides a distorted theoretical account of the most basic relations in a monetary economy and an illusionary vision of what a modern central bank could achieve. The last section of the article uses the recent monetary history of Ukraine to illustrate the pitfalls and illusions of inflation targeting.

Highlights

Three renowned economists have declared recently that “inflation-forecast targeting can be considered the state of the art for monetary policy” (Adrian, Laxton, and Obstfeld 2018, 14)
In the aftermath of a first academic conference that reviewed the experience with inflation targeting (IT) in 1994 and thanks to increased interest and research in IT by the International Monetary Fund (IMF) since 1997, thirteen central banks had moved to IT by the year 2000
If we look at the inflation expectations of market participants,25 they have been at odds with both actual inflation and the National Bank of Ukraine (NBU) forecast

Summary

INTRODUCTION

Three renowned economists have declared recently that “inflation-forecast targeting can be considered the state of the art for monetary policy” (Adrian, Laxton, and Obstfeld 2018, 14). The description of money price formation as relying on the actuality and necessity of individuals’ market actions produces a praxeological quantity theory of money, fully integrated with the marginal value theory It is the demand for money and individuals’ purposeful buying and selling of goods and services, analytically referred to as the “real” cash balances doctrine, that bring about the nominal anchoring of the economy, to borrow the vocabulary of the inflation-targeting literature. The sequence, speed and magnitude of the price increases are engendered by and depend on the additional exchanges made possible by the lowered demand for money This realistic and theoretically consistent view contrasts patently with the mechanistic approach followed by IT proponents who ground the role of inflation expectations in the self-validating properties of rational expectations rather than in the causal relations produced by human action. C umulative internal and external depreciation of the hryvnia relative to the US dollar, 2000–19

80 Domestic Consumer Price Depreciation

Findings

CONCLUSION