Abstract
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.
Highlights
IntroductionInflation Targeting (IT) has attracted much attention as a new promised monetary regime
In the recent decades, Inflation Targeting (IT) has attracted much attention as a new promised monetary regime
The paper examines the response of the main monetary instrument in developing countries with inflation targeting to world monetary shocks after years of building the credibility of the framework and moving to the full-fledged form and conducting macroprudential polices
Summary
Inflation Targeting (IT) has attracted much attention as a new promised monetary regime. Based on what monetary policy can do, the advantages of low inflation and the necessity of having a nominal anchor, many countries have developed the rationale for adopting IT. During the late 1960s and 1970s, the world has experienced high and unstable inflation rates and the promises of activists to keep the output and the unemployment close to their full-employment levels have failed at all the time. Many countries have encountered recessions as eradicating high inflation rates resulted in high social and economic costs [9]. The studies [24] and [47] provide evidence that the negative nexus between inflation and unemployment holds only in the short run and turns into a vertical one in the long-run, i.e. there is no long run trade-off between them due to the adjustments in inflation expectations. The monetary policy has neutral real effects in the long-run and the monetary policy should only focus on achieving price stability
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