Describe the strategy of inflation targeting. Why have many countries begun to use this strategy instead of targeting money growth? What are the advantages and disadvantages of inflation targeting?

Question

What will be an ideal response?

Answer 1

Under inflation targeting, the central bank announces the inflation rate that it will try to achieve over the next 1 to 4 years. Countries have moved to inflation targeting because money-growth targeting had problems in the 1980s as money demand became unstable. Inflation targeting has the advantage of sidestepping the problem of instability in money demand, of being easier to explain to the public, and of increasing the central bank's accountability to the public. But the major disadvantage of inflation targeting is that the long lags through which inflation responds to monetary policy make it difficult for the central bank to judge what policy actions are needed.