On the Future of Inflation Targeting in East Asia

• Author: Ulrich Volz
• DOI: http://doi.org/10.1111/rode.12173
• Published date: 01 August 2015
• Date: 01 August 2015

On the Future of Inflation Targeting in East Asia

Ulrich Volz*

Abstract

This article analyzes the problems associated with inflation targeting (IT) regimes in a number of East

Asian countries. It scrutinizes the policy conflicts that can arise when a central bank that has adopted a

formal inflation target to guide the conduct of monetary policy simultaneously manages the exchange rate

and pursues financial stability objectives. To this end, it empirically investigates the importance of exchange

rate and terms of trade movements as determinants of inflation rates across East Asian economies and dis-

cusses the role of central banks in guarding financial stability and the ways this may conflict with an IT

regime. The article argues that IT never really has been a suitable monetary framework for East Asian

countries and that it should hence be supplanted by transparent monetary frameworks that explicitly recog-

nize the multiple goals that are being pursued by East Asian central banks.

It is with regret that we announce the death of Inflation Targeting. The

monetary regime, known affectionately as “IT” to its friends, evidently

passed away in September 2008. That the demise of IT has not been offi-

cially announced until now testifies to the esteem in which it was widely

held, its usefulness as a figurehead for central banks, and fears that there

might be no good candidates to assume its position as preferred anchor for

monetary policy. (Frankel, 2012)

1. Introduction

Since the early 1990s, inflation targeting (IT) has been the dominant paradigm in

central banking. Defined by Bernanke et al. (2001, p. 4) as “a framework for mon-

etary policy characterized by the public announcement of official quantitative targets

(or target ranges) for the inflation rate over one or more time horizons, and by

explicit acknowledgement that low, stable inflation is monetary policy’s primary long-

run goal”, IT was first adopted as a formal monetary policy framework by a number

of advanced countries—New Zealand (1990), Canada (1991), the United Kingdom

(1992), Australia (1993) and Sweden (1993). Soon after, a growing number of devel-

oping and emerging economies followed suit, not least because IT has been promoted

as state of the art of central banking by institutions such as the International Mon-

etary Fund and the World Bank. Today, around 30 central banks are generally

regarded as fully fledged inflation targeters (Berg et al., 2013).1

In East Asia, IT regimes were adopted in the aftermath of the Asian financial crisis

by Korea (1998), Thailand (2000) and the Philippines (2002), and later by Indonesia

* Volz: Department of Economics, SOAS, University of London, Thornhaugh Street, Russell Square,

London WC1H 0XG, UK. Tel: +44 207 898 4721; E-mail:uv1@soas.ac.uk. Also affiliated to German Devel-

opment Institute/Deutsches Institut für Entwicklungspolitik (DIE). This article builds on previous work on

this topic that is published in Volz (2015). Very helpful comments by Ingo Bordon, Menzie Chinn, Gunther

Schnabl, two anonymous referees and participants at a conference on “Exchange Rates, Monetary Policy

and Financial Stability in Emerging Markets and Developing Countries”, held in Leipzig in October 2014,

are gratefully acknowledged. All remaining errors and shortcomings of this article are solely those of the

author.

Review of Development Economics, 19(3), 638–652, 2015

DOI:10.1111/rode.12173

© 2015 John Wiley & Sons Ltd