LInflation targeting is generally considered the best monetary policy strategy, particularly for economies open to trade, even small ones. Inaugurated by the New Zealand and Canada in the early 1990s – quickly followed by Australia, Sweden and the United Kingdom, then, notably, by Iceland and Norway – it is credited with having radically reduced the level and volatility of inflation wherever it has been consistently applied.
Low and predictable inflation has proven to be conducive to better economic performance, making it possible to avoid (at least until the shock of the Covid-19 pandemic) excessive variations in income distribution, following unforeseen inflationary surges. .
It is not difficult to understand the positive effects of inflation targeting. Such an approach forces the central bank to pay much more scrupulous attention to price stability than previously used strategies. It establishes transparency of monetary policy objectives and the measures defined to achieve them, all signals that build public confidence.
Denmark and the single currency
And yet, the commonly accepted and repeated narrative about inflation targeting is based on a false assumption. In reality, many of the economies that have adopted this strategy are not open at all. And conversely, countries with very open economies have not adopted such a strategy.
THE numbers of the World Bank show that the ratio of trade to gross domestic product (GDP) is only about 50% in Australia and New Zealand, 70% in Canada and the United Kingdom, and 90% in Scandinavia. While they are 384% for Hong Kong, 336% for Singapore, 140% for Switzerland or 128% for Denmark – none of these economies use inflation targeting.
Considering the excellent performance of the latter group, one might think that inflation targeting is not suitable for the most open economies, which have adopted a different strategy.
Denmark, an immediate neighbor of the vast euro zone, has linked its exchange rate to the single currency. Hong Kong also fixed its exchange rate, although for quite different reasons, which probably cannot apply to other economies. A currency board system (currency board) was there created in 1983, when the Hong Kong dollar experienced a catastrophic depreciation after China declared that it would regain sovereignty over the region in 1997. This type of political event, apart from macroeconomic considerations, can have major effects on exchange rates. By deciding on a fixed exchange rate, Hong Kong could now protect its economy from such shocks.
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