Inflation Targeting under Global Trends Exposure

Olga Gennadievna Arkadeva

, Natalia Vyacheslavovna Berezina

and Mikhail Vladislavovich Arkadev

Chuvash State University named after I.N. Ulyanov, Moskovsky avenue, Cheboksary, Russia

ChROO "Common cause", Cheboksary, Russia

Keywords: Inflation targeting, monetary policy, fiscal policy, global imbalances, socio-economic development.

Abstract: The purpose of the study was to update the understanding of inflation targeting tools, that can help to develop

inflation targeting policy under global trends exposure. The growth of financial, economical, social problems

and climate change make mainstream paradigm of sustainable economic development precarious. The

contradiction between unconstrained elasticity of capital supply and negative consequences of current

approach to natural resources exploration and demographic headwind amplifying political decisions make

find new trade-offs between price stability and output volatility. The study aims at the identification of a range

of monetary policy tools: traditional and unconventional tools and their influence on output and inflation. The

study provided research of international monetary policies across inflation targeting, full employment, and

financial stability. We specified global trends exposure on sovereign monetary policy and its adoption to

changing environment. The theoretical results of the study are expressed in streamlining international

experience of inflation targeting and knowledge systematization about central banks approach to achieve their

domestic mandates to stabilise inflation and maintain output at potential under global trends. The practical

significance of the research refers to reveal imbalances of Russian inflation targeting tools compared to

international practice and to provide specific recommendations to achieve well-balanced policy for state social

and economic development.

1 INTRODUCTION

Contemporary social and economic development

makes us reconsider basic knowledge about inflation

targeting grounded on the quantity theory of money.

The main prerequisites for such a revision are the

causal relationship between income and money

supply, changes in the structure of liquidity and the

increased role of costs, which is determined, in

particular, by changes in wages and prices of

commodities, which became clearly visible in the

post-pandemic period.

The growth of global trade and the emergence of

value chains that opened access to cheaper inputs,

demographic trends that increased the supply of labor

in the economy, and digitalization in the labor market

that stifled wage growth and potentially flattened the

Phillips curves, were the main factors that slowed

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down global inflation. The fallout from the 2008

global financial crisis, driven by disinflationary

demand, has been further impacted by the crisis

during the COVID-19 pandemic. Classical

economists believed that money and finance are

nothing more than a side effect of the action of

fundamental causal factors operating in the real

economy (Cao J., 2019). However, while developing

quantitative analysis techniques, they believed that

the money supply determines the rate of inflation,

which can significantly affect the real economy

(Vercelli, 2019). D. Hume, I. Fisher, M. Friedman

recognized that the increase in money supply can

stimulate income growth, but they argued that this

effect is temporary. While neoclassical scientists

suggest that price and wage flexibility maintains full

employment and equilibrium in the short term, neo-

Keynesians argue that optimal equilibrium can only

be achieved through policies that manage to

Arkadeva, O., Berezina, N. and Arkadev, M.

Inﬂation Targeting under Global Trends Exposure.

DOI: 10.5220/0010682000003169

In Proceedings of the International Scientiﬁc-Practical Conference "Ensuring the Stability and Security of Socio-Economic Systems: Overcoming the Threats of the Crisis Space" (SES 2021),

pages 33-37

ISBN: 978-989-758-546-3

counteract market failures. In the case of stable

nominal wages, fiscal and monetary policies can be

aimed at regulating price inflation to ensure that real

wages are sustainable in line with the concept of full

employment (Blanchard, 2013; Petrakis, 2020). The

current stage of the development of ideas about state

regulation of economy and ensuring the sustainable

functioning of financial relations is characterized by

numerous attempts to update and revise approaches to

the use of monetary instruments and anti-inflationary

regulation instruments. Methods and instruments of

modern monetary policy, which is carried out by

central banks with the aim of influencing the

economy indirectly through credit institutions and

financial markets, are effective if two conditions are

met:

1. The ratio of the components of the money

supply to the monetary base is stable, respectively,

the effect of the money multiplier is unchanged.

2. Stability of money demand and the level of

economic activity, which are expressed in the

stability of the money demand function and the

investment multiplier. If the first condition is met, the

central bank can estimate the level of the monetary

base that can be controlled to achieve the desired level

of economic activity. From the second condition, it is

possible to derive the assumed level of the interest

rate through which the bank influences the demand of

households. The main attention of the authors is

focused on the problem of accumulation and

maintenance of global imbalances that cause

distortions in prices, private and public savings, and

the profitability of investments in the financial system

and in the real sector. The process of financialization

and a chronic lack of investment in the real economy

has generated financial inflation, caused structural

imbalances in the economy and determined its

consequences for that part of society whose income

and welfare depend mainly on investments in the real

sector (Arkadeva, 2019; 2021). Inflation targeting is

based on the premise that a tight inflation target is a

prerequisite for sustainable growth and job creation,

and that monetary stability, combined with

microprudential supervision, ensures financial

stability. The hypothesis of the study is the provision

that the current stage involves the development and

use of fundamentally new tools to curb inflation for

the economy and society in order to level the

consequences of the impact of global trends. Based

on the study of materials from the leading central

banks of the world, an attempt to streamline the

development directions of such instruments and

identify their specifics was made.

2 MATERIALS AND METHODS

We used general scientific methods of theoretical

research in the study:

– methods of induction to observe the usage of a

single tool to stabilise inflation and to make the

hypothesis on patterns of tool’s influence on social

and economic processes under global trends

exposure;

– methods of deduction to extend common

patterns of inflation targeting to different spheres of

social and economic developing for further

recommendations on strengthening monetary policy;

– methods of analysis to highlight and to study

specific tools of inflation targeting and monetary

policy;

– methods of synthesis to create a holistic view of

transforming monetary policy under global trends

exposure.

We carried out the observation of different

monetary tools usage by policymakers in many

advanced economies, compared them to highlight

general and specific characteristics that affected the

inflation

We also used general logical methods in the study

– abstraction, analogue, aggregation, idealisation, to

highlight patterns of emerge disinflation and inflation

symptoms and tools that were used to take control

under these processes.

3 RESULTS AND DISCUSSION

We studied the objectives of monetary policy of the

top central banks. Most of policymakers declare price

stability as the single aim of monetary policy; ECB,

Bank of England, Bank of Canada, Riksbank, and

Bank of Japan are amid these banks. A small group of

central banks in additional to price stability mandate

have an explicit mandate of responsibility for full

employment, that has the same weight as price

stability. Job promoting mandate have Federal

Reserve System, the Reserve Bank of Australia and

the Reserve Bank of New Zealand.

Ensuring price stability is being rethought as a

monetary policy goal and is highly influenced by

global trends. So, according to the traditional

approach to monetary regulation, price stability is

achieved through targeting inflation and floating

exchange rates. Floating exchange rates are

considered to be effective instruments of global

shocks absorption and domestic production and

import flows management. Changes in the national

SES 2021 - INTERNATIONAL SCIENTIFIC-PRACTICAL CONFERENCE "ENSURING THE STABILITY AND SECURITY OF

SOCIO - ECONOMIC SYSTEMS: OVERCOMING THE THREATS OF THE CRISIS SPACE"

currency are projected onto imports, aligning

domestic production to a level close to optimal while

keeping prices within a given inflation (Corsetti G.,

2010; Benigno G., 2006).

In the era of globalization the importance of

international trade and the movement of capital have

grown significantly. Growing international trade

increases the role of external demand and supply in

the management of domestic productive resources.

Relocation of production facilities to countries with

cheap labor, automation of production, simplification

of supply chains create a disinflationary effect. The

globalization of trade has reduced the price of the

consumer basket from a quarter to two-thirds

(Feigelbaum P., 2016). Fading inflation is a global

trend, although recently researchers have noted new

factors provoking inflation. Demographic challenges

– population aging and massive retirement of the

baby boomer generation – create an internal shift in

the labor market and an extension of the Phillips

curve. Awareness of the vulnerability of global

commodity chains, clearly shaped during the

COVID-19 pandemic, is simultaneously driving the

scientific community, as well as the government and

central banks, to the thought of production localizing,

so there is a possibility that the disinflationary force

of globalization will decrease in the future.

Globalization has increased market competition,

equalizing producer prices and weakening the

dependence of the state of domestic labor markets and

inflation.

In international trade the US dollar accounts for

half of payments – five times the US share in world

imports and three times the US share in world

exports. Thus, import prices do not reflect changes in

trade between regions, as they are influenced by the

US dollar index. In addition to international

payments, the US dollar is of great importance to the

financial sector. Two-thirds of securities are

denominated in US dollars, the same ratio foreign

exchange reserves have, denominated in US dollars

(Gopinath G., 2018; Gourinchas P., 2019). Dollar

dependence is especially relevant for emerging

markets, where any external crises with increased

amplitude affect them.

Some researchers believe that the global financial

cycle is the US dollar cycle. According to the Deputy

Governor of the Bank of England B. Broadbent, in the

globalized financial system the monetary policy of a

single country ultimately has little impact on

domestic financial conditions. As a result of the

financial ties intensification, the monetary policy,

formed by the central banks of main importance on a

global scale, is acquiring a global character.

Therefore, the parameters of monetary policy in

different countries become symmetric and fluctuating

in the national currency are limited and eventually

become close to a fixed one. This connection can be

traced in the example of the Bank of Japan, which had

to build up its balance sheet and correct internal

imbalances caused by the monetary policies of other

countries.

Full employment as a goal of monetary policy is

also criticized by the scientific and professional

community. The belief that the federal government

has a responsibility for full employment, has

economical sense and appeared at the Great

Depression time. At the end of the Second World War

there was some concerns that job market could not

accept millions of American soldiers after

demobilization. In the Employment Act of 1946, the

Congress directed the federal government mandatory

to foster and to promote conditions under which there

will be afforded useful employment, for those able,

willing, and seeking to work, and to promote

maximum employment, production, and purchasing

power. An amendment to the Federal Reserve Act in

1977 added a new dimension to the current objectives

of US monetary policy – promoting maximum

employment. A year later passed Full Employment

and Balanced Growth Act, requiring from the Federal

Reserve report to the Congress about how monetary

policy was supporting the goals of the act. At the

same time, it is not so much the provision of work for

every citizen that is of greater importance for this

direction of monetary policy, but the reduction of

poverty, inequality of various social groups,

discrimination and crime, and the elimination of

economic problems facing black communities.

Addressing climate change is becoming

increasingly important in the choice of monetary

policy instruments. At the present stage, no central

bank has decarbonization and the transition to a green

economy as priority goals of activity. However, most

central banks attach great importance to this problem,

calling to direct efforts within their powers to reduce

financial risks associated with climate, which can

affect the safety and reliability of financial

institutions and can potentially threaten the stability

of the financial system. Researchers agree that

climate change and the transition to a low-carbon

economy pose both risks and opportunities for the

financial sector. Extreme natural events associated

with climate change – drought, forest fires,

hurricanes, abnormal weather conditions – are

predicted to increase in frequency and magnitude,

increasing damage to households and organizations

over time, disrupting corporate supply chains,

Inﬂation Targeting under Global Trends Exposure

impacting profitability, creditworthiness of

organizations and changing approaches to

determining the value of collateral. Financial

institutions that do not have well-developed

mechanisms for measuring, monitoring, and

managing climate-related risks may face losses on

climate-dependent assets. Conversely, sustainable

risk management, scenario analysis and forward-

looking planning will help to ensure that the financial

institutions are resilient to the impact of climate-

related risk events and ensure a smooth transition to a

sustainable economy. The world's banks are

collaborating on joint solutions through the Basel

Committee Working Group (TFCR) and the Network

for Greening the Financial System (NGFS), which

brings together 83 central banks and financial

supervisors, whose goal is to accelerate the scale up

of green finance and develop recommendations for

regarding the role of central banks in climate change.

Before the 2008 financial crisis, the interest rate

was the main instrument of monetary policy. Changes

in the central bank rate affect key indicators of the

economy: business activity, rates of commercial

banks and the cost of borrowing in financial markets.

Disinflationary trends in recent years have forced

global central banks to keep interest rates at

historically record lows. The base interest rate is

influenced by global trends and structural factors,

such as population aging, leading to the increase in

demand for savings and the decrease in demand for

borrowed funds, as well as the decline in the share of

industry in GDP, which reduces the demand for

capital by enterprises (Goodhart, 2020).

According to M. Saunders, member of the

Monetary Policy Committee of the Bank of England,

it is easier to return to the base inflation that is at

levels higher than the target, than to the one that is

lower. Researchers agree that in order to manage risk,

monetary policy must be aggressive against downside

risks – a “take big strides quickly” strategy in the

Bank of England's terminology. If too little incentive

is provided, and its impact on the economy is weaker

than expected, then the costs of hysteresis will be

disproportionately higher. At the same time, it is

emphasized that the management of the key rate has

its own limit, or an effective lower limit, the

movement below which leads to a negative effect.

The functioning of financial intermediation is

distorted by reducing the profitability of financial

institutions and squeezing lending. Therefore,

following the exhaustion of the key rate resource,

unconventional instruments are currently being

developed and used, but they are not ideal substitutes

for the key rate. The impact of many of them on

economic processes remains uncertain compared to

the relatively well-understood effect of rate

management.

In the post-pandemic period, in foreign practice

direct financing instruments are developing. They

allow banks and certain economic entities to borrow

funds with appropriate collateral for a long time at a

rate close to the bank's key rate (Bank of England –

TFS family of programs, ECB – TLTRO). Such

programs provide cheap financial resources to

organizations and to small and medium-sized

enterprises, which contributes to the growth of

lending, positively affects the profits of banks and

plays a key role in supporting the flow of credit to the

private sector. Quantitative Easing (QE) to buy assets

that drive down long-term interest rates was found to

be effective during the 2008 financial crisis,

mitigating the post-2016 Brexit referendum financial

turmoil and the 2020 COVID crisis. Quantitative

easing provides additional liquidity, relieves “instant

liquidity” strains from the government bond market,

stimulates the economy, lowers long-term interest

rates, counteracts the deterioration of the

government's financial system, and reduces the risk

of turbulence from financial markets to the

macroeconomy. Research of the effects of QE has

identified its primary impact on interest rates,

financial markets and asset prices. The impact of QE

on GDP and inflation is more limited, according to

the US Federal Reserve, no conclusive evidence of

the impact of QE on bank lending has been found.

In addition to QE, other tools are used.

Controlling the yield curve of government bonds is

the central bank's management of the yield on

government long-term bonds, in which the bank

artificially influences the demand in stock markets.

The instrument has been used by the Bank of Japan

since 2016 to replace QE. REPO transactions provide

unlimited liquidity guaranteed by a wide range of

securities. The Bank of England jointly with the

Treasury provides REPOs through the CTRF

(Contingent Term Repo Facility). A toolkit for

purchasing corporate bonds is being developed to

directly provide liquidity to non-banking

organizations. The Bank of England and the Treasury

are acquiring bonds through the CCFF (Covid

Corporate Financing Facility). The Fed teamed up

with the Treasury through CPFF (Commercial Paper

Funding Facility) and MMLF (Money Market Mutual

Fund Liquidity Facility) to support investment funds

experiencing customer churn. The creation of these

institutions helped to ease the panic in the short-term

bond market and stop the outflow of funds from

investment funds in March 2020. The acquisition of

SES 2021 - INTERNATIONAL SCIENTIFIC-PRACTICAL CONFERENCE "ENSURING THE STABILITY AND SECURITY OF

SOCIO - ECONOMIC SYSTEMS: OVERCOMING THE THREATS OF THE CRISIS SPACE"

shares in investment funds is carried out by the Bank

of Japan to support financial markets and stimulate

the economy. The bank purchases shares in Japanese

mutual funds (ETFs) and real estate investment trusts

(REITs).

Researchers agree that the effectiveness of the use

of any single instrument (change in the key rate,

acquisition of assets) separately will have a weak

effect, therefore a combination of instruments is

important in order to achieve synergy, which will give

a more pronounced effect. A side effect of

unconventional instruments is the permanent growth

of central bank balance sheets. When new monetary

policy mechanisms were launched during the World

Financial Crisis, central banks believed that balance

sheet expansion would be short-term. Attempts to

reduce the balance caused pressure on the stock

market. The presence of securities on the bank's

balance sheet purchased under QE limits its ability to

increase the base rate, which can be raised only after

the reserves are cleared. The acquisition by central

banks of assets other than government bonds (for

example, the acquisition of corporate bonds, ETFs,

and REITs by the Bank of Japan) inevitably increases

the risks associated with owning such assets. Asset

inflation, expressed in the growth of the stock market

and real estate prices, carries risks of stability of the

financial system in the long term.

4 CONCLUSIONS

The growing risk of a liquidity trap in a near-zero rate

environment reinforces the importance of joint

implementation of monetary and fiscal policy

measures to preserve jobs and economic activity.

However, the unified policy is more inert due to its

bureaucracy, as it requires the introduction and the

adoption of bills. At the same time, a time lag for the

implementation of measures is laid in the final result,

therefore, when developing measures, it makes sense

to use a set of tools that give less effect, but require

less time for their adoption. At the same time, both

the composition of the instruments and their influence

on the final result change. If in conditions of positive

interest rates the main task was to increase the supply

by stimulating the production of goods and services,

then in conditions of zero interest rates the main task

is to increase the demand. Stimulating the production

of goods and services becomes counterproductive,

carrying a disinflationary effect. In these conditions,

tax deductions for the modernization of equipment by

legal entities, or the purchase of certain goods by

individuals, have a positive effect. The state creates

demand through infrastructure projects or military

spending. The increase in the workload increases the

supply in the labor market, which leads to the

decrease in total wages. Because of this, the aggregate

demand decreases, twisting a deflationary spiral.

Changes in the marginal costs of producers associated

with falling commodity prices or changes in taxation

also affect the bottom line. By laying down price cuts

in the future, the manufacturer creates disinflationary

expectations. If, within the framework of fiscal

measures to overcome the crisis, a reduction in

income taxation is envisaged, then the negative

effects are eliminated with the help of QE.

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Inﬂation Targeting under Global Trends Exposure