Should Developing Countries Target Low, Single-Digit Inflation to Promote Growth and Employment?

Abstract

The impetus behind this chapter is the increasing global recognition that the pre-crisis macroeconomic policy paradigm needs to be revisited. The former managing director of the IMF argued the case for a ‘wholesale re-examination of macroeconomic policy principles’ in the wake of the Great Recession of 2008–2009 at a March 2011 conference.² He observed that ‘recent experience has raised profound questions about the pre-crisis consensus on macroeconomic policies’.³ Moreover, he specifically noted the pre-crisis advice of ‘keeping inflation low and stable was the best way to secure optimal economic performance’. However, the debate on inflation targeting (IT) has been reignited and needs to be revisited.⁴ Olivier Blanchard, the director of the IMF’s Research Department, pointed out ‘key aspects of the old framework that no longer hold post-crisis, including the pre-crisis convergence on a “beautiful construction” of a single monetary policy target — low and stable inflation — and a single policy instrument — the central bank’s policy rate’. He lamented that ‘Beauty is not synonymous with truth’.⁵ Even back in 2005, the IMF questioned the desirability of single-digit inflation targets, highlighting that keeping inflation at relatively low levels for a sustained period required high real interest rates and constrained potential seigniorage income. Moreover, they acknowledged that a consensus on the appropriate inflation range for low income countries was lacking (IMF 2005).