Inflation targeting and financial stability in emerging markets

Abstract

This paper aims at investigating whether emerging market inflation targeters are more financially vulnerable than their non-targeting counterparts. It further assesses the extent to which targeting central banks are less responsive to financial imbalances, compared to those implementing alternative policy strategies. Based on a sample of 26 emerging countries, including 13 targeters, the analysis suggests that monetary policy in targeting countries is relatively more sensitive to financial risks. However, despite stronger central banks’ responses to financial imbalances, the financial sector appears to be more fragile for targeters. Our conclusion therefore challenges the view that central banks, through their policy interest rates, can guarantee the stability of the financial system. It rather suggests that the control of inflation should remain the primary monetary policy objective, while a (macro)prudential authority would be in charge of the financial stability objective.