One of the most common monetary policy strategies employed by countries wishing to achieve price stability is inflation targeting, which involves five different elements. Despite the commonality of its usage, inflation targeting has numerous disadvantages as cited by critics (Mishkin & Eakins, 2012).
Delayed signaling is one of the top reasons of why there is a disadvantage to using inflation targeting as a method of monetary policy. In other words, the time it takes for noticeable changes to take effect in the economy after inflation targeting has been implemented creates a delay that causes there to be a question about what truly caused the economic change (Mishkin & Eakins, 2012).
Another disadvantage associated with using inflation targeting is that it creates a rigid environment where monetary policy makers are not as flexible as they could be when dealing with circumstances that could not be previously accounted for. However, this argument for inflation targeting being flawed can be disproved because multiple variables are taken into account before implementing such a strategy. Monetary policy makers are also able to adjust their strategy as needed (Mishkin & Eakins, 2012).
The third disadvantage of using inflation targeting as pointed out by critics is that there is a potential for increased output fluctuations (Mishkin & Eakins, 2012). The basis for such an argument is that those increased output fluctuations are a consequence of focusing on interest during times when it is above target. A counter argument could be made that monetary policy makers are extremely mindful of such situations and carefully select positive interest rates for this reason (Mishkin & Eakins, 2012).
The fourth disadvantage that critics argu...
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...differs from the Fed in how it implements monetary policy is through its handling of reserve requirements. Instead of just requiring member banks to retain a portion of its deposits like the Fed requires of its member banks, the European Central Bank pays its member banks interest on the reserves held. Because of this difference, member banks of the European Central Bank enjoy a cost of compliance that is lower than their American counterparts.
In summary, the European Central Bank and the Fed have similar tasks to accomplish with similar tools of monetary policy, but they contrast in some of the ways that they use those tools. In some ways, their differences might be seen as improvements over how each one compares monetary policy.
Mishkin, F. S., & Eakins, S. G. (2012). Financial markets and institutions (7th ed.). Upper Saddle River, NJ: Prentice Hall.
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