Explain how inflation targeting operates in the UK and Critically Essay

Explain how inflation targeting operates in the UK and Critically evaluate the benefits of inflation targeting - Essay Example Inflation is all about price stability and it has been agreed by the economist that a rate of between (0-3) percent is the good enough rate fro the economy. With stable prices at that rate, consumer confidence is raised hence propelling the economy, if the consumer confidence is lower, then the economy will be stuck (Ben 2003). Inflation can only be made success through central banks making price stability its primary objective through strong institutional commitment to attaining that. United Kingdom was not the first country to introduce the inflation instead there are countries like Canada which did it ahead of them. Many countries over time have followed suit to introduce the inflation targeting within their economies with many others looking for technical assistance to help them introduce it (Richard 2005). Japan is one of the few who have not adopted it yet because of its well developed economy with rather stable inflation rate. UK inflation is therefore currently more stable in comparison with the past performance. UK quit ERM in 1992 due to rising tension between having to follow a tight policy framework in order to maintain existing exchange rate and the other option of having to cut the domestic downfall by taking down interest rates it (Richard 2005). ... With such big concern about inflation and well versed with knowledge of the trade-off between output and the inflation, the policy maker will then fix interest rates through adjustments informed by the knowledge on relative demand to supply and inflation. The central bank then set in the money markets the nominal interest rate and since prices of goods are somehow rigid then there will be movements around the real rate that always stand in absence of such moves by the central bank (Mervyn 2005). Due to these sticky prices, if a crisis hit the economy, it slips inflation away from the target and central bank can not quickly take it back to the track instead it has to take the longer old route by factoring in the monetary policy on what is the most. This older route will include having to factor in the bigger things that include having to go over the expected demands and supply and he pressure it will have on one another, that is to say the productive capacity of the economy and its co st implication as well as whether the economy is still on the track in relative to the expected inflation (Paul 1998). After all that considerations the central bank will then design a way to bring quickly inflation back to target with consideration of the impact it will have on the output. It will then have to decide on whether to aggregate demand should be stimulated or not and whether to be neutral. With all that there are unobservable effects of inflation on unemployment which it raises, the interest rates and growth of the economy through supply. The monetary policy committee (MPC) targets inflation by setting interest rates. When a shock hit the economy the committee action is not felt immediately. The results of adjustments in interest rates could yield tangible results after even