Do inflation-targeting central banks adjust inflation targets to meet the target?

Abstract

Under inflation targeting, central banks are supposed to set an inflation target in advance and then try to make the actual inflation reach the target. However, central banks may have an incentive to adjust their targets to meet their goals. Panel data analysis with a sample of 19 inflation-targeting countries show that changes in the inflation target significantly and positively respond to the deviation of the inflation rate from the target in the previous period. This result supports the idea that inflation-targeting central banks adjust the inflation target to meet the target when they miss it. Further analysis suggests that such a relationship is more evident in central banks with low credibility or weak performance compared with high credibility or strong performance. Finally, we show that such behavior of central banks can lead to equilibrium indeterminacy in the standard New Keynesian model. Further, such behavior renders achieving equilibrium determinacy harder for central banks even in more realistic models. This result may imply that when central banks respond to missed inflation targets by adjusting their targets and to enhance the credibility and stabilize the inflation rate, they may end up destabilizing inflation expectations and the inflation rate.