Why the same inflation target may not fit all countries?

As Federal Reserve changes gears to Average Inflation targeting, it has to be seen what other central banks do.

Meanwhile one question to be asked is why most developed country central banks target 2% inflation? This St Louis Fed blogpost analyses drivers of inflation across countries.

Over the past few decades, many central banks have adopted the monetary policy of inflation targeting, in which they set an explicit target rate for inflation. For the U.S., the European Union, the United Kingdom and Japan, this target inflation rate is at or near 2%. But is the same inflation target optimal for all economies?

In a Regional Economist article, Research Officer and Economist YiLi Chien and Research Associate Julie Bennett noted that inflation rates for several advanced economies have fallen short of their 2% targets for most of the past decade, which raises questions about the optimal level of inflation targets.

“In practice, the specific 2% inflation target may not be universally optimal,” the authors wrote. “The driving forces behind inflation rates could be quite different across countries; therefore, the implementation of the same monetary policy tools—such as forward guidance or quantitative easing—could have varied effects on inflation rates.”

In their analysis, the authors found the main contributors to inflation have varied across countries.

Using national consumer price index (CPI) data from the Paris-based Organization for Economic Cooperation and Development (OECD),¹ the authors identified different inflation drivers for the U.S., Japan, France, Germany and the U.K. for the period from January 2012 to September 2019. For each country, the average overall CPI inflation rate was below 2%, ranging from 1.8% in the U.K. to 0.69% in Japan.

For all the countries except Japan, the category of housing, water, electricity, gas and other fuel expenditures contributed most to overall inflation. However, this broad category’s share of overall inflation varied by country. In the U.S., expenditures in this category contributed 1 percentage point to the average overall inflation rate, representing a 64% share of overall inflation. In France, Germany and the U.K., this share was much lower at 26%, 29% and 33%, respectively, while in Japan it was 13%.

Interesting…

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