The Case for Using Nominal GDP as a Benchmark

Until the currency crashes of the 1990s, emerging and developing countries tended to target their exchange rates. Many then also switched to inflation targets; but they tend to miss these targets even more often than the advanced countries do.

The problem with these approaches to monetary-policy targeting is that even though a particular numerical target may be reasonable when it is set, subsequent unexpected developments often make the target hard to live with. The monetary authorities are then confronted with a harsh choice between violating their announced target, and thus undermining the credibility that was the point of the exercise, or setting policy too tight or too loose, thus doing unnecessary damage to the economy.

Major central banks can generally withstand failure to achieve targets without a fatal loss of credibility. The Deutsche Bundesbank routinely missed its money-supply targets, and yet remained a credible, admired institution. More recently, inflation expectations in the UK and US remained well anchored even when the Bank of England and the Federal Reserve had to walk away from the unemployment thresholds they had announced.

The situation is different in emerging and developing economies. These countries’ need to establish policy credibility tends to be more acute, whether as a result of histories of high inflation, an absence of credible institutions, or political pressure to monetise budget deficits. They need targets with which they can really live.

via The Guardian

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza