FOREX THEORY
Types of Monetary Policy
(Part 2)
They know that some
inflation is a good thing, but out-of-control inflation can remove the
confidence people have in their economy, their job, and ultimately, their
money.
By having target inflation
levels, central banks help market participants better understand how they (the
central bankers) will deal with the current economic landscape.
Let’s take a look at an
example.
Back in January of 2010,
inflation in the U.K. shot up to 3.5% from 2.9% in just one month. With a
target inflation rate of 2%, the new 3.5% rate was well above the Bank of
England’s comfort zone.
Mervyn King, the governor
of the BOE, followed up the report by reassuring people that temporary factors
caused the sudden jump, and that the current inflation rate would fall in the
near term with minimal action from the BOE.
Whether or not his
statements turned out to be true is not the point here. We just want to show
that the market is in a better place when it knows why the central bank does or
doesn’t do something in relation to its target interest rate.
Simply put, traders like
stability.
Central banks like
stability.
Economies like stability.
Knowing that inflation targets exist will help a trader to understand why a
central bank does what it does.
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