Keep Your Word: Time Varying Inflation Targets and Inflation Targeting Performance

Abstract

This paper investigates the implicit inflation targets of inflation targeting (IT) CBs (CBs). This allows us to analyze whether the actions of the IT CBs coincide with their announced targets. The implicit (perceived) inflation targets of IT CBs derived from the actions (policy interest rates) are calculated before and after IT adoption. We construct a panel data set of implicit inflation targets to investigate the determinants of time-variation of inflation targets. We conclude that after adoption of IT implicit targets become significantly lower. Also, we identify the factors that cause CBs to change their implicit targets. Finally, we find that CBs that do not follow their announced targets miss their inflation targets. In other words, we identify one of the factors that causes IT CBs to miss their targets. Inflation targeting CBs should follow their announced targets when setting policy interest rates. This paper uncovers the dynamics behind time-variation in implicit inflation targets presented in several studies. The findings of this paper provides an explanation for the success of IT in especially developing countries. The empirical results deliver many policy implications especially for IT CBs.