Question

1. You are on the board of governors of the South Sudanese Central Bank, in charge of South Sudan’s monetary policy. Because South Sudan is a relatively new country, they are still defining the central bank’s mandate. Some board members are arguing for a zero inflation target. Others disagree.
   1. Explain two reasons a zero inflation target might be good for South Sudan (3 points)

2. Explain two reasons a zero inflation target might be bad for South Sudan (3 points)

Answer 1

The following two reasons might be good for South Sudan's zero inflation target.

1)Cost of inflation

a)if inflation creeps up, then it can cause various economic costs such as uncertainty leading to lower investment, loss of international competitiveness and reduced value of savings.

  b)Maintaining inflation close to the target, it avoids these costs and provides a framework for sustained economic growth.

2)Clarity

a)An inflation target provides clarity for monetary policy.

b)Alternatives have been tried with less success. For example, in the early 1980's, monetarism suggested trying to target the money supply - but this indirect targeting of inflation proved limited as the link between the money supply and inflation was weaker than expected.

The following two reasons might be bad for South Sudan's Zero inflation target.

1)Cost push inflation may cause a temporary blip in inflation.

a)Just before the recession of 2009, experienced cost-push inflation of 5% due to high oil prices.

b)To target 2% inflation would have required high interest rates, which leads to lower growth.

2)Central Banks start to ignore more pressing problems.

a) The ECB set monetary policy to keep inflation in the Eurozone on target.

b)Rather than trying to prevent a prolonged slump, they were fixated on the importance of low inflation.