Expanded Summary

Emerging market economies are very different from advanced economies and therefore, in the article we have emphasized important implications that need to be factored in when designing macroeconomic policies. According to the aspect that targeting inflation in emerging markets may lead to poor macroeconomic outcomes, in the article we are covering major elements that inflation targeting comprises and the conditions that are crucial for achieving inflation targeting’s efficiency. Additionaly, we clarify how the emerging market economies differ from advanced economies and then we discuss why there is a need of developing strong fiscal, financial and monetary institutions to the success of inflation targeting in emerging markets. In emerging market countries international monetary fund’s role is quite critical in promoting the success of inflation. As a precondition of inflation targeting is considered existence of financial dollarization, according to which floating exchange rate may be dangerous and cause financial instability. According to the importance of price stability for the country’s economic growth it is important to use monetary policy, which is responsible for maintaining price stability. The exchange rate related studies have shown that one of the main features of the inflation targeting regime is a floating exchange rate. First of all, we have outlined some key preconditions for inflation targeting that need to be taken into account, these are: medium term numerical targets for inflation, commitment to price stability as the primary goal of monetary fund and the independence of the central bank. The inflation performance is found to be the best for the countries with the most independent central banks; under the independence we mean that the central bank needs to be prohibited from funding government deficits, the monetary policy board has to be insulated from the political processes and the monetary policy instruments has to be set up without interference from the government.

In Georgia, under the monetary policy regime the inflation target level is announced in advance, which will be maintained in the medium term. The national bank of Georgia determines the level of targeted inflation and the main goal is to define the optimal level of inflation.  One of the advantages of inflation targeting is transparency and the simplicity of communication with the public, to which the central bank also gives the great importance. When defining the optimal level of inflation, there are several factors that need to be taken into account by the monetary policy committee. First of all, the prices of the various products that are included in the consumer basket do not change proportionally. As we need to use consumer price index (CPI) for estimating inflation, we have to note that the CPI is characterized by several biases, such as: substitution bias, quality bias and the new product bias. The first bias means that the CPI measures changes in price levels indirectly; it does not take into account consumer preferences when price changes take place. The second bias is connected with the quality of goods and services, which gets improved over time and therefore, it leads to the price increases; in this case as well, the CPI does not reflect inflation attributed to quality changes. The third, new product bias means that the new products permanently enter the market and substitute the old ones.            

High inflation in characterized by large fluctuations and it is difficult to predict the country’s economic growth in the long run. Therefore, price stability is the fundamental factor for the country’s sustainable economic growth. In the long run the desirable rate of inflation in Georgia is 3%. It should be noted that in Georgia before 2018 the inflation target level was more than 3%, by which are characterized developing countries; high levels of inflation is mainly caused by a rapid growth in productivity. 

Overall, the emerging market countries have greater concerns about exchange rate fluctuations than advance countries. They are more likely to find that depreciations lead to a rise in inflation as a result of higher import prices and greater demand for exports. In emerging countries much of their debt is denominated in foreign currency and because of currency depreciation the debt burden of domestic firms increases. 

However, an increasing number of emerging market countries are adopting inflation targeting as their monetary policy regime. One of the main preconditions for inflation targeting is the existence of financial dollarization, during which the floating exchange rate can be a real threat. Let us consider an emerging market countries where debts are denominated in dollars and the firms depend on local currency. In this case, private sector and banks’ balance can be sensitive to the nominal and real exchange rate shifts.

To summarize, based on the basic principles of inflation targeting, price stability is the main concern of the monetary policy. In terms of the floating exchange rate, emerging market countries are more sensitive compared to the advanced countries. Overall the inflation targeting can be an effective tool for emerging market countries to manage their monetary policy, however emerging market countries would benefit by focusing more attention to the institutional development.