Inflation Targeting and World Monetary Shocks: Evidence from Developing Economies
The paper assesses the co-movement of local and foreign interest rate for developing countries with a full-fledged inflation targeting framework during and after the 2008 financial crisis. A panel linear optimizing monetary model is estimated by the fixed effects with spatial correlation standard errors over quarterly span from Q12007 to Q2 2019. The results suggest that inflation targeters are highly vulnerable to external monetary shocks, even after years of notable efforts to de-dollarization and complete shift towards a full-fledged inflation targeting. From a regime evaluation prospective, the inflation targeters’ response to world monetary shocks is compared to that of a group of fixed exchange rate rule economies and managed exchange rate countries with other monetary regimes. The findings provide evidence that inflation targeting countries are not different in their interest rate response to world monetary shocks compared to non-inflation targeting countries’, and instead of having more flexibility, inflation targeters show stronger reaction to world monetary shocks. These results are found robust when generated out from different subsamples and under assumptions of strict and flexible inflation targeting and policy inertia. The findings indicate that adopting inflation targeting as a framework for monetary policy does not by itself support the overall macroperformance and independence of monetary policy or force continuing commitment to the inflation targeting conditions.
Noura Abu Asab,
Inflation Targeting and World Monetary Shocks: Evidence from Developing Economies, International Journal of Business and Economics Research.
Vol. 9, No. 3,
2020, pp. 140-150.
Agénor, P. R. (1999). Monetary policy under flexible exchange rates: an introduction to inflation targeting. Policy Research Working Papers. The World Bank.
Albagli, E., & Schmidt-Hebbel, K. (2003, March). By how much and why do inflation targeters miss their targets? In Conference on Monetary Policy and Learning.
Aliyu, S. U. R., & Englama, A. (2009). Is Nigeria ready for inflation targeting? MPRA Paper No. 14870
Al-Marhubi, F. and T. D. Willett (1995). The anti inﬂationary inﬂuence of corporatist structures and central bank independence: The importance of the hump shaped hypothesis. Public Choice 84 (1-2), 153–162
Alpanda, S., & Honig, A. (2010). Political monetary cycles and a de facto ranking of central bank independence. Journal of International Money and Finance, 29 (6), 1003-1023.
Ball, L. (1992). Why does high inﬂation raise inﬂation uncertainty? Journal of Monetary Economics 29 (3), 371–388.
Ball, L. M. and N. Sheridan (2004). Does inﬂation targeting matter? In the inﬂation targeting debate, pp. 249–282. University of Chicago Press.
Barro, R. J. and D. B. Gordon (1983). Rules, discretion and reputation in a model of monetary policy. Journal of monetary economics 12 (1), 101–121.
Bernanke, B. S., T. Laubach, F. S. Mishkin, and A. S. Posen (1999). Inﬂation Targeting. Princenton University Press.
Buiter, W. (2006, October). Rethinking inflation targeting and central bank independence. In Turkish Economic Association Conference, Ankara, September.
Caballero, R. J., Cowan, K., & Kearns, J. (2005). Fear of sudden stops: lessons from Australia and Chile. The Journal of Policy Reform, 8 (4), 313-354.
Capistr´an, C. and M. Ramos-Francia (2010). Does inﬂation targeting affect the dispersion of inﬂation expectations? Journal of Money, Credit and Banking 42 (1), 113–134.
Caselli, F. G., & Roitman, A. (2019). Nonlinear exchange-rate pass-through in emerging markets. International Finance, 22 (3), 279-306.
Catão, M. L., & Terrones, M. M. (2016). Financial de-dollarization: A global perspective and the Peruvian experience. International Monetary Fund.
Céspedes, L. F., Chang, R., & Velasco, A. (2014). Is inflation targeting still on target? The recent experience of Latin America. International Finance, 17 (2), 185-208.
Cukierman, A. and A. H. Meltzer (1986). A theory of ambiguity, credibility, and inﬂation under discretion and asymmetric information. Econometrica: Journal of the Econometric Society, 1099–1128.
Cukierman, A., S. B. Web, and B. Neyapti (1992). Measuring the independence of central banks and its eﬀect on policy outcomes. The World Bank Economic Review 6 (3), 353–398.
De Haan, J. and W. J. Kooi (2000). Does central bank independence really matter?: New evidence for developing countries using a new indicator. Journal of Banking & Finance 24 (4), 643–664.
Drew, A. and ¨O. Karagedikli (2008). Some beneﬁts of monetary policy transparency in new zealand. Technical report, Reserve Bank of New Zealand.
Driscoll, J. C., & Kraay, A. C. (1998). Consistent covariance matrix estimation with spatially dependent panel data. Review of economics and statistics, 80 (4), 549-560.
Edwards, S. (2006). The relationship between exchange rates and inflation targeting revisited (No. w12163). National Bureau of Economic Research.
Fernández-Arias, E., Yeyati, E. L., & Morón, E. (2006). Financial Dollarization and Dedollarization [with Comments]. Economía, 6 (2), 37-100.
Frankel, J., Schmukler, S. L., & Serven, L. (2004). Global transmission of interest rates: monetary independence and currency regime. Journal of international Money and Finance, 23 (5), 701-733.
Friedman, M. (1968). The role of monetary policy. The American Economic Review 58, 1–17.
Friedman, M. (1977). Nobel lecture: inﬂation and unemployment. The Journal of Political Economy, 451–472.
Fountas, S. (2010). Inﬂation, inﬂation uncertainty and growth: Are they related? Economic Modelling 27 (5), 896–899.
Galindo, A. J., & Leiderman, L. (2005). Living with Dollarization and the Route to Dedollarization. Inter-American Development Bank Working Paper.
Garcia-Escribano, M. M. (2010). Peru: Drivers of de-dollarization (No. 10-169). International Monetary Fund.
Grilli, V., D. Masciandaro, and G. Tabellini (1994). Political and monetary institutions and public ﬁnancial policies in the industrial countries. Monetary and Fiscal Policy 2, 179–226.
Hess, G., & Morris, C. S. (1996). The long-run costs of moderate inflation.Economic Review, Federal Reserve Bank of KansasCity, Second Quarter, 81, 71-88.
Ho, C., & McCauley, R. N. (2003). Living with flexible exchange rates: issues and recent experience in inflation targeting emerging market economies. BIS working paper no. 130.
Hochreiter, E., Schmidt-Hebbel, K., & Winckler, G. (2002). Monetary Union: European Lessons, Latin American Prospects. The North American Journal of Economics and Finance, 13 (3), 297-321.
Holub, T., & Hurník, J. (2008). Ten years of Czech inflation targeting: missed targets and anchored expectations. Emerging Markets Finance and Trade, 44 (6), 67-86.
Im, T. N., Dabadie, M., & Sokha, N. (2007). Dollarization in Cambodia. National Bank of Cambodia.
Judson, R., & Orphanides, A. (1996). Inflation, Volatility, and Growth, Finance and Economics. Board of Governors, Federal Reserve of United States, Washington, DC, Discussion Paper, (96-19).
Keskek, S. and M. Orhan (2010). Inﬂation and inﬂation uncertainty in turkey. Applied Economics 42 (10), 1281–1291.
Kydland, F. E. and E. C. Prescott (1977). Rules rather than discretion: The inconsistency of optimal plans. The Journal of Political Economy, 473–491.
Levy-Yeyati, E. L. (2003). Financial dedollarization: a carrot and stick approach. Available at SSRN 412369.
Levy-Yeyati, E. L. (2006). Financial dollarization: evaluating the consequences. Economic Policy, 21 (45), 62-118.
Lin, H.-Y. and H.-P. Chu (2013). Are ﬁscal deﬁcits inﬂationary? Journal of International Money and Finance 32, 214–233.
Loayza, O., & Soto, R. (2002). Inflation targeting: design, performance, challenges. Banco Central de Chile.
Mathew, J. T. (2003). Measuring central bank independence in twenty-ﬁve countries: A new index of institutional quality.
Metin-Özcan, K., & Us, V. (2007). Dedollarization in Turkey after decades of dollarization: A myth or reality? Physica A: Statistical Mechanics and its Applications, 385 (1), 292-306.
Mishkin, F. S., & Schmidt-Hebbel, K. (2007). Does inflation targeting make a difference? (No. w12876). National Bureau of Economic Research.
Neumann, M. J. and J. Von Hagen (2002). Does inﬂation targeting matter? Technical report, ZEI working paper.
Pesaran, M. (2004). General diagnostic tests for cross section dependence in panels. CESifo Working Paper, No. 1229.
Phelps, E. S. (1968). Money-wage dynamics and labor-market equilibrium. The Journal of Political Economy, 678–711.
Reinhart, C. M., Rogoff, K. S., & Savastano, M. A. (2003). Addicted to dollars (No. w10015). National Bureau of Economic Research.
Rennhack R, Nozaki M (2006): Financial dollarization in Latin America. IMF Working Paper, no. 7.
Roger, M. S., & Stone, M. M. R. (2005). On target? The international experience with achieving inflation targets (No. 5-163). International Monetary Fund.
Schaechter, A., M. R. Stone, and M. Zelmer (2000). Adopting inﬂation targeting: Practical issues for emerging market countries, Volume 202. International monetary fund Washington, DC.
Schmidt-Hebbel, K., & Tapia, M. (2002). Monetary policy implementation and results in twenty inflation-targeting countries (Vol. 166). Banco Central de Chile.
Siklos, P. L. (2008). No single deﬁnition of central bank independence is right for all countries. European Journal of Political Economy 24 (4), 802–816.
Svensson, L. E. (1999). Inflation targeting as a monetary policy rule. Journal of Monetary Economics, 43 (3), 607-654.
Svensson, L. E. (2000). Open-economy inflation targeting. Journal of International Economics, 50 (1), 155-183.
Thornton, J. (2007). The relationship between inﬂation and inﬂation uncertainty in emerging market economies. Southern Economic Journal, 858–870.
Vernengo, M., & Bradbury, M. (2011). The limits to dollarization in Ecuador: Lessons from Argentina. Journal of World-Systems Research, 17 (2), 457-462.
Walsh, C. E. (2009). Inﬂation targeting: What have we learned? International Finance 12 (2), 195–233.
Wooldridge, J. M. (2002). Econometric Analysis of Cross Section and Panel Data. Cambridge, MA: MIT Press.