Apr 14, 2011 (LBO) – An International Monetary Fund policy paper has proposed a forecasting and policy analysis system (FPAS) to help start an inflation targeting regime for Sri Lanka which suggested a range of 4.0 to 7.0 percent a year as a target.
The paper said Sri Lanka’s tight peg also complicated monetary policy. A peg ties a country or ‘externally anchors’ its inflation to that of the pegged currency which in Sri Lanka’s case the US dollar.
An inflation target based on a consumer price index on the other hand is a domestic anchor. In a pegged exchange rate a central bank will essentially try to target both anchors and eventually fail.
Depending on how realistic the index was and how the target was achieved, the exchange rate has to be allowed to move to effectively control inflation.
In general, a country with a price index which under-state inflation less and achieved its targets well would have a stronger exchange rate.
Under the gold standard, all countries had the same domestic anchor – gold – and as a result exchange rates were fixed and there was no sustained inflation in the world.
New Zealand originally set a target of 0-2 percent, which according to popular legend, was set by the finance minister during