PERI Working Paper Series, Number 62
Abstract: Many countries in the developing world have adopted an approach to
monetary policy that focuses on maintaining a low level of inflation, to the
exclusion of other important objectives such as employment generation,
increasing investment or reducing poverty, despite the widespread
evidence that moderate levels of inflation have few or no costs. Some have
even adopted formal “inflation targeting”, an approach which commits the
central bank to hitting a fairly rigid inflation target, often as low as 2%.
However, this focus has led to slower economic growth and lower
employment growth, without succeeding in lowering inflation at a smaller
economic cost than traditional methods of inflation fighting. Clearly, it is
time to find an alternative to inflation targeting.
This paper presents the real targeting approach to monetary policy, which
I argue is superior alternative to the costly and ineffective inflation
targeting approach. Under this real targeting approach, central banks are
given a country appropriate target such as employment growth,
unemployment, real GDP or investment, usually subject to an inflation
constraint. Given these two targets-the real target and the constraint-the
central bank will find multiple tools to reach these targets, designing new
tools and rediscovering old tools such as asset based reserve requirements
and other credit allocation techniques. The real targeting approach might
also be complemented by other policies, such as capital management
techniques to deal with possible capital flight. The real targeting approach
has the potential to make central bank policy more transparent, more
accountable, and more socially useful than most currently existing central
bank structures.