Does Institutional Quality matter to the Inflation Targeting-Financial Stability Nexus?

Abstract

Abstract This study examines the quality institutions role played in the inflation targeting- financial stability nexus. A sample of 65 developed and developing countries, including 33 inflation-targeting countries (10 developed and 23 developing), and 32 non-inflation-targeting countries (12 developed and 20 developing), during the 1996 - 2020 period. Using Two Step GMM estimation, results show that inflation targeting stimulates financial stability. This positive relationship between inflation targeting and financial stability is proved, regardless of the inflation targeting regime in place; Soft or Full-Fledged. Results from institutional quality variables prove that inflation-targeting countries with poor institutional quality are financially vulnerable, and that for good institutional quality are able to promote financial stability. JEL classification number: E4, E52, E58. Keywords: Inflation targeting, Financial stability, Developed and developing countries, Quality of institutions, Tow Step GMM System.