Evaluation of Inflation Targeting Policy in Australia and Canada

This article evaluates the impact of inflation targeting policy on macroeconomic variables in Australia and Canada. It compares the effectiveness of the policy in both countries and provides a comparative analysis.

Running head: ECONOMICS
Economics
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Table of Contents
Evaluation of inflation targeting policy in Australia and Canada...................................................2
Australia.......................................................................................................................................2
Impact of inflation targeting policy on macroeconomic variables..............................................2
Canada.........................................................................................................................................5
Impact of inflation targeting policy on macroeconomic variables..............................................5
Comparative analysis between Australia and Canada.................................................................7
References........................................................................................................................................9

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Evaluation of inflation targeting policy in Australia and Canada
Australia
In Australia, the inflation targeting policy is used as the main framework in designing
monetary policy. Following the decision of central banks of different countries, the Reserve
Bank of Australia adapted inflation targeting policy in 1990s (Debelle, 2016). In 1996,
understanding the importance of inflation targeting policy government and RBA formalized the
monetary policy agreement in a statement on the conduct of monetary policy.
Impact of inflation targeting policy on macroeconomic variables
Table 1: Summary statists of macroeconomic variables pre and post inflation target
(Source: rba.gov.au, 2019)
Price stability
Since the adaption of inflation targeting policy, rate of consumer price inflation termed as
headline inflation in Australia has remained within the targeted range. The inflation expectation
is also within the targeted limit. It is the responsibility of Reserve bank to monitor closely the on-
going inflation trend in the economy. This excludes items, which have particularly high or low

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rate of inflation. The measure allows RBA to consider the temporary factors affecting inflation
and helps to assess broader inflationary pressure (rba.gov.au., 2019). The underlying inflation in
the economy has average close to headline inflation since 1990s. The low and stable price level
resulted from inflation targeting policy has helped to lower uncertainty in the economy ensuring
a stable growth.
Figure 1: Average inflation in Australia (pre and post inflation target)
(Source: rba.gov.au, 2019)
Output stability
The impact of inflation targeting policy on output stability depends on three factors – the
selection of range or targeted inflation point, attention on the medium terms and specification of
underlying inflation measure. For Australia, inflation target has been set in such a way that it
allows an increased flexibility. The inflation target in Australia has specified a thick point. The
second aspect of inflation targeting framework is the scope of output stability over the policy
horizon (Bernanke et al., 2018). In case of Australia, the medium term inflation targeting policy
has resulted in a stable economic growth. One example of policy effectiveness is the monetary
policy response during Asian crisis.

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Unemployment
Maintenance of full employment in the economy is one of the primary objectives of
inflation targeting policy in Australia (Debelle, 2018). With a stable price level and a stable
economic growth, labor market condition improved. The figure below shows long run inflation
and unemployment in
Figure 2: Australia unemployment and inflation in long run
(Source: rba.gov.au, 2019)
Consistency of underlying inflation to that of the targeted range resulted in a good
economic output. The average rate of unemployment in the current decade is lower than the
previous decade, which is again lower than the previous decade.

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Canada
In Canada, inflation targeting policy was adapted in 1991. Canada was the second
country adapting inflation targeting policy, next to New Zealand. The policy was first introduce
by the finance minister in budgetary speech. Bank of Canada supports and designs the inflation
targeting policy (Beaudry & Ruge‐Murcia, 2017). Currently, central bank of Canada targets to
keep the inflation rate within 2 percent.
Impact of inflation targeting policy on macroeconomic variables
Table 2: Summary statists of macroeconomic variables pre and post inflation target
(Source: Beaudry & Ruge‐Murcia, 2017)

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Price stability
Figure 3: Inflation rate in pre and post –inflation target period
(Source: Lange, 2016)
In Canada, the adaption of inflation targeting has lowered the average inflation rate. Not
only average inflation rate has declined but also it has become more stable compared to period
prior to adaption of inflation targeting. As the inflation rate declined to 2 percent, the expectation
of businesses and forecasters started to fall in line with the inflation target. Initially, inflation
target was for 2-year time horizon. With initial success, the inflation expectation was strengthen
for a horizon of 6 to 10 year (Lange, 2016). The long-term inflation expectation in the financial
market fell within the targeted range of 2 percent by the middle of 1997. The low inflation target
in Canada has become increasingly credible with a change in overall process of inflation.
Output stability
The objective of inflation targeting policy to keep inflation at a low a stable level often
comes at the high price of increasing volatility in aggregate output. However, there was a decline
in volatility of output since the adaption of inflation targeting. Two factors contributed to a stable

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economic output. Increased credulity towards monetary policy resulted in a stable behavior of
output (Obstfeld et al., 2016). Secondly, the policy itself has room for improvement in the
forward-looking policy framework. As a result, both growth in GDP and output gap have
become more stable since 1990s.
Figure 4: Economic growth and output gap from 1975 to 2004
(Source: Beaudry, P., & Ruge‐Murcia, 2017)
Unemployment
Greater stability in price level and output led to so positive changes to the real economy.
The unemployment rate has become less volatile over in the past decade of inflation targeting
policy compared to previous 10 years (Lange, 2016). Unemployment rate in the last two years
has reached to its lowest level in the last 25 years.
Comparative analysis between Australia and Canada
Table 3: Comparison of inflation targeting policy between Australia and Canada

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Pre inflation targeting Post inflation targeting
Inflatio
n
growt
h s.d. inflation
s.d.
growth
Inflatio
n
growt
h s.d. inflation
s.d.
growth
Canada 5.7 2.8 2.9 2.9 2 2.7 1.3 2.1
Australi
a 6 3.2 2.9 2.7 2.6 3.8 1.6 1.1
(Source: Dotsey, 2019)
The table above compares economic outcome of inflation targeting policy in Australia
and Canada. The average inflation rate for ten years prior to adaption of inflation targeting policy
in Australia was 6.0. For Canada, the average inflation rate prior to inflation targeting policy was
5.7 percent. The volatility of inflation rate in both Canada and Australia were 2.9. After adaption
of inflation targeting policy, rate of inflation in Canada declined to 2 percent while that for
Australia fell to 2 percent. The corresponding inflation rate in Australia was 2.6 percent. Both the
nation were successful in achieving the targeted inflation rate along with stability in price level.
In terms of economic growth, the adaption of inflation targeting raised the economic growth
from 3.2 percent to 3.8 percent (Dotsey, 2019). For Canada, however economic growth lowered
to 2.7 percent from 2.8 percent during period of pre-inflation target. Output growth is also more
stable in Australia than that in Canada. Therefore, in terms of overall economic prosperity
inflation targeting policy is more successful in Australia than that in Canada.

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References
Beaudry, P., & Ruge‐Murcia, F. (2017). Canadian inflation targeting. Canadian Journal of
Economics/Revue canadienne d'économique, 50(5), 1556-1572.
Bernanke, B. S., Laubach, T., Mishkin, F. S., & Posen, A. S. (2018). Inflation targeting: lessons
from the international experience. Princeton University Press.
Debelle, G. (2018). Twenty-five Years of Inflation Targeting in Australia | Speeches | RBA.
Retrieved from https://www.rba.gov.au/speeches/2018/sp-dg-2018-04-12.html
Dotsey, M. (2019). A Review of Inflation Targeting in Developed Countries. Retrieved from
https://www.philadelphiafed.org/-/media/research-and-data/publications/business-
review/2006/q3/br_q3-2006-2_review_inflation.pdf
Lange, R. H. (2016). The Monetary Transmission Mechanism and Inflation Targeting: A
Regime-Switching VAR Approach for Canada. Applied Economics and Finance, 3(2),
263-279.
Obstfeld, M. M., Clinton, K., Kamenik, M. O., Laxton, M. D., Ustyugova, M. Y., & Wang, H.
(2016). How to improve inflation targeting in Canada. International Monetary Fund.
rba.gov.au. (2019). Australia's Inflation Target. Retrieved from
https://www.rba.gov.au/education/resources/explainers/pdf/australias-inflation-target.pdf