Does Inflation Targeting Policy Matter for Inflation Performance?

Abstract

Purpose – Inflation targeting (IT) is a practice that central banks around the world began to adopt as early as 1990. Due to the high accountability and high transparency of central banks under IT policy, the practice expected that inflation targets would have better inflation performance. In this study, it is explored whether inflation targeting policy has positive effects on inflation performance, focusing on inflation persistence. Also, it is explored whether the behavior of inflation rates overshooting or undershooting a target range (or a tolerance band around a target level) is asymmetric. Design/Methodology/Approach – An autoregressive (AR) model is adapted with a self-exciting threshold autoregressive (TAR) model to study inflation persistence before and after inflation targeting was adopted, respectively. To address issues that events unrelated to inflation targeting policy could explain the findings, counterfactual exercises for non- inflation target are conducted. Findings – It was found that inflation target, particularly developed inflation target, have experienced a decrease in inflation persistence after implanting inflation targeting. Also, there is limited evidence on the asymmetrical behavior of inflation rates between overshooting and undershooting an inflation target range, or tolerance band, around a target level. Research Implications – The findings in this study support the positive effect of IT policy on inflation performance. In particular, it is stronger for developed inflation target than less developed inflation target. In addition, the findings support that most central banks do not show asymmetrical responses to inflation rates between overshooting and undershooting a target range or tolerance band around a target level.