Inflation Targeting - Shortcomings

Shortcomings

Increases in inflation (CPI) are not necessarily coupled to any factor internal to a country's economy and adjusting strictly or blindly adjusting interest rates will potentially be ineffectual and restrict economic growth when it was not necessary to do so. Bernie Fraser, governor of Reserve Bank of Australia from 1989–1996, raised this concern in 2008 in response to another hike in their interest rates.

Supporters of a nominal income target criticize the propensity of inflation targeting to neglect output shocks by focusing solely on the price level. Adherents of market monetarism, led by Scott Sumner, argue that in the United States, the Federal Reserve's mandate is to stabilize both output and the price level, and that consequently a nominal income target would better suit the Fed's mandate. Australian economist John Quiggin, who has endorsed nominal income targeting, has stated that "A system of nominal GDP targeting would maintain or enhance the transparency associated with a system based on stated targets, while restoring the balance missing from a monetary policy based solely on the goal of price stability." Quiggin blamed the late-2000s recession on inflation targeting, saying:

Inflation targeting led central bankers, most notably Alan Greenspan of the US Fed, to ignore or even applaud the unsustainable bubbles in speculative real estate that produced the crisis, and to react too slowly as the evidence emerged. Worse still, in the post-crisis environment, achievement of inflation targets has no longer promoted stable economic growth. Rather, low inflation has been a drag on growth. But with inflation clearly under control, central bankers like former European Central Bank President Jean-Claude Trichet have been able to describe their own performance as ‘impeccable’, even as the economies and currencies they manage appear headed for collapse.

In an op-ed in 2012, Harvard University economist Jeffrey Frankel suggested that inflation targeting "evidently passed away in September 2008," referencing the 2007–2012 global financial crisis. Frankel suggested that "that central banks that had been relying on had not paid enough attention to asset-price bubbles," and also criticized inflation targeting for "inappropriate responses to supply shocks and terms-of-trade shocks." In turn, Frankel suggested that nominal income targeting or product-price targeting would succeed inflation targeting as the dominant monetary policy regime.