Explicit Inflation Targeting Research Articles

Inflation targeting and inflation communication of the Federal Reserve: Words and deeds

This paper utilizes recent advances in automated text analysis to investigate whether and how the shifting inflation focus in the monetary policy strategy of the Federal Reserve (Fed) is reflected in the transcripts of the Federal Open Market Committee (FOMC) meetings over the course of the last quarter century. We ascertain that inflation references have surged in the FOMC’s communication long before the implementation of the Fed’s explicit inflation targeting framework in 2012. We go on to assess whether the FOMC’s inflation communication had a direct impact on the monetary policy decisions of the Fed by estimating Taylor-type rules augmented by the FOMC’s tone-measured inflation references. We find these to induce quantitatively small but positive effects on the policy rate and the inflation reaction coefficient. In this sense, the FOMC communication on inflation reflects the Fed’s monetary policy stance quite closely. However, all these effects already occur prior to 2012, whereas the actual implementation of the inflation targeting framework itself elicits no further monetary tightening. Our evidence is in line with the FOMC’s communication at the time framing the implementation of inflation targeting as a continuation of the pursuit of the price stability objective rather than as a genuine change in the Fed’s monetary policy regime.

Uluslararası Rezervler Döviz Piyasalarındaki Dalgalanmaları Önlemede Yeterli midir?

Finansal piyasalarda oluşabilecek ani ve beklenmedik durumların yaratacağı olumsuz etkilerin giderilmesinde önemli bir araç olarak görülen uluslararası rezervlere olan talep küreselleşme olgusu ile birlikte artış göstermiştir. Rezerv biriktirmenin fırsat maliyetinin belirlenmesi ve tutulan rezervlerin doğru yönetilmesi ise özellikle gelişmekte olan ülkeler için önem arz etmektedir. Bu çalışmada, Türkiye ekonomisinde açık enflasyon hedeflemesine geçiş ile birlikte Ocak 2005-Ocak 2022 dönemine ait veriler kullanılarak uluslararası rezervlerin nominal döviz kuru üzerindeki ilişkisi incelenmektedir. Elde edilen sonuçlara göre, geleneksel nedensellik testlerinde uluslararası rezervlerden nominal döviz kuruna doğru nedensellik bulunmamıştır. Öte yandan asimetrik nedensellik testinde ise uluslararası brüt rezervlerin pozitif bileşeninden nominal döviz kurunun negatif bileşenine doğru, uluslararası brüt rezervlerin negatif bileşeninden nominal döviz kurunun pozitif bileşenine doğru nedensellik bulunmaktadır. Zamansal olarak 2009 yılından sonra her yılın Haziran-Temmuz-Ağustos-Eylül aylarında uluslararası rezervlerden nominal döviz kuruna doğru nedensellik olduğu tespit edilmiştir.

Credibility and Explicit Inflation Targeting

Credibility and Explicit Inflation Targeting

The Federal Reserve’s move to an explicit inflation target: incremental policy shifts in techno-political institutions

This paper analyzes the US Federal Reserve (Fed)’s landmark 2012 decision to adopt an explicit inflation target for the first time in its history. The paper focuses on explaining the dynamics of this policy shift. The relevant literatures authoritatively establish types of incremental change and the transformative nature of this kind of change. Using the case of the Fed’s policy shift, this paper advances a framework for explaining when the likelihood of such change increases, and how ‘policy entrepreneurs’’ strategies can affect this likelihood. Its theoretical discussions are broadly applicable to other techno-political institutions. The paper’s evidence comes from previously non-public internal Fed transcripts, and its discussions draw from diverse literatures – on the Fed and central banks, on multilateral economic institutions with similarly techno-political characteristics, historical institutionalism, as well as Macroeconomics.

Inflation targeting & implications of oil shocks for inflation expectations in oil-importing and exporting economies: Evidence from three Nordic Kingdoms

In the context of the debate on inflation targeting, this paper analyses the impact of the oil shocks on inflation expectations in three Nordic Kingdoms. A NARDL framework is applied to data from Jan 1994 to June 2018 on the Kingdoms of Norway, Sweden and Denmark. Our key findings suggest that there are considerable nonlinearities and asymmetries in the relationship between inflation expectations, oil shocks and economic determinants of inflation expectations. The expectations formulated in the past have a very significant negative impact on future inflation expectations (adaptive expectations) and there is heterogeneity in the adaptiveness pace. A country's net oil trade position seems to reflect on the impact of oil price shocks on the inflation expectations and there is asymmetry and downwards inflation expectations rigidity. There is strong evidence of exchange rate pass-through to inflation expectations. Prevailing regimes of price stability can support to anchor future inflation expectations. Reduction in fiscal deficit and increases in money supply has a positive impact while unemployment has a negative impact on inflation expectations. The cumulative multiplier analysis showed that the impact of oil shock was symmetric in Sweden and Denmark but asymmetric in Norway which is a large net oil exporter. Besides the adoption of explicit inflation targeting regime by Sweden and Norway, the inflation expectations in the underlying economies are prone to the oil price shocks and macroeconomic determinants. These shocks pose a whole set of challenges to monetary authorities in these economies and the findings in the subject treatise provide some guidance on how each shock may transmit.

Monetary Polıcy Interest Rate Channel in Turkey: Toda-Yamamoto Method (2011-2018)

This study analyzes the channel through which monetary policy has affected real economic activity in Turkey during 2011Q1-2018Q2. There is a novel monetary policy stance of the Turkish Central Bank (TCMB) from 2011 on, after initiation of explicit inflation targeting from 2006 on. Within the framework financial stability is added to previous target of price stability and diversified interest rates and liquidity measures have been introduced as new monetary policy tools along with classical short-term interest rate. Existence of interest channel has been tested by two causality methods, namely: Granger and Toda-Yamamoto. Results imply that interest channel is not operative in Turkey in the traditional Keynesian sense, bu rather higher demand leads to higher prices (and vice versa) affecting interest rates in return. Findings do not comply with findings of the previous studies that interest rate channel is effective in Turkey.

Inflation target and (a)symmetries in the oil price pass-through to inflation

In this paper we employ state-space models to estimate the pass-through of oil price changes to consumer prices for a large sample of countries from 1970 to 2017. By controlling for self-selection bias and endogeneity and allowing for different responses to positive and negative price changes, we asses the differences between explicit inflation targeting (IT) countries and a control group. Surprisingly perhaps, our results suggest that the pass-through is higher for IT countries. Our main contribution is to show that these is mainly due to IT countries having a significant higher pass-through than non-IT countries when the oil price decreases: a 10% drop in oil price leads about a 0.11% drop in inflation in ITers (of which 4pp are explained by the monetary regime). Importantly, we show that adopting IT reduces the asymmetry of the pass-through. We run several robustness checks and conclude that falling oil prices are more welcomed by the central banks with an IT framework, in particular during deflationary episodes or when inflation is above the target.

Inflation target and anchor of inflation forecasts in Japan

In literature, a number of studies argued that an explicit inflation targeting regime provides less uncertainty about future inflation rates through anchoring expectations. However, it is far from clear whether the argument still holds true when the central bank faces a serious difficulty in achieving the target. The Bank of Japan (BOJ) is a central bank that has adopted an explicit inflation target but faced a serious difficulty in achieving it. The purpose of this paper is to explore whether the explicit inflation targeting regime could anchor inflation expectations in Japan. In the analysis, we estimate panel Phillips curves by using Japanese forecaster-level data of “ESP Forecast”. We find significant structural changes in how to form inflation expectations. Before the BOJ announced the 2% inflation target, the estimated anchor of inflation expectations was negative. The new target increased the estimated anchor to significant positive values. This suggests that the BOJ's explicit inflation target could partly anchor inflation expectations. However, the estimated anchor has never reached the target. More importantly it started to decline when it turned out that the 2% target would not be feasible in the short-run. This implies that an explicit inflation targeting needs to be a feasible one to anchor inflation expectations persistently.

The Monetary Transmission Mechanism in Canada: A Time-Varying Vector Autoregression with Stochastic Volatility

This study uses the state-space representation of a time-varying vector autoregression with stochastic volatility (TVP-VAR-SV) to study monetary policy and private sector behaviour in Canada. The main results indicate that both shock variances and autoregressive coefficients of the VAR have evolved systematically over time. The time-varying coefficients of the systematic component of the VAR suggest that monetary policy has become more proactive and less reactive regarding inflation since the early-1990s, which coincides with the adoption of explicit inflation targets. Monetary policy is now able to focus mainly on movements in the output gap to prevent future increases in inflation. The coefficients on the policy rate in both the output gap and inflation equations suggest that the private sector and therefore the transmission mechanism have become more sensitive to monetary policy responses. On the other hand, the coefficients on the output gap in the equations for both inflation and the policy rate have been relatively stable over this period, consistent with view that monetary policy remains more forward-looking regarding inflation than being reactive to inflation surprises as in the past.

Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market Implications

High-frequency empirical evidence suggests that inflation expectations in the United States became better anchored after the Federal Reserve began communicating a numerical inflation target. Using an event-study approach, we find that forward measures of inflation compensation became unresponsive to news about current inflation after the adoption of an explicit inflation target. In contrast, we find that forward measures of nominal compensation in Japan continued to drift with news about current inflation, even after the Bank of Japan adopted a numerical inflation target. These empirical findings have implications for the term structure of interest rates in the United States. In a calibrated macro-finance model, we show that the apparent anchoring of inflation expectations implies lower term premiums in longer-term bond yields and decreases the slope of the yield curve.

Examining the success of the central banks in inflation targeting countries: the dynamics of the inflation gap and institutional characteristics

Abstract This paper analyzes the performance of the central banks in inflation targeting (IT) countries by examining their success in achieving their explicit inflation targets. For this purpose, we decompose the inflation gap, the difference between actual inflation and the inflation target, into predictable and unpredictable components. We argue that the central banks are successful if the predictable component diminishes over time. The predictable component of the inflation gap is measured by the conditional mean of a parsimonious time-varying autoregressive model. Our results find considerable heterogeneity in the success of these IT countries in achieving their targets at the start of this policy regime. Our findings suggest that the central banks of the IT adopting countries started targeting inflation implicitly before becoming an explicit inflation targeter. The panel data analysis suggests that the relative success of these countries in reducing the gap is influenced by their institutional characteristics, particularly fiscal discipline and macroeconomic performance.

Nonlinear Dynamics in Exchange Rate Pass-Through and Inflation Persistence: The Case of Turkish Economy

As a small open economy, inflation is still largely driven by exchange rate developments in Turkey. Despite the fact that exchange rate pass-through (ERPT) to inflation has declined after the adoption of explicit inflation targeting in 2003, its contribution to the consumer prices and producer prices inflation is still prominent. Furthermore, recent studies show that inflation persistence appears to be another issue preventing from achieving price stability. This paper aims to explore the non-linear dynamics of ERPT and inflation persistence in the case of Turkey by employing Smooth Transition Regression (STR) models. The main motivation of this study is to identify different regimes characterized by the magnitude of exchange rate movements in which ERPT and persistence in inflation indicators differ. Estimation results for the period 2003-2017 shows that inflation persistence and ERPT for Consumer Price Index (CPI) is high in regime with a sizeable import price shock. Additionally, STR estimation results indicate that ERPT and import price pass-through to Producer Price Index (PPI) is more influential in ?high depreciation? regime.

Inflation Targeting, Recursive Inattentiveness, and Heterogeneous Beliefs

We consider a monetary authority that provides an explicit inflation target in order to align expectations with the policy objective. However, biased perceptions of the target may arise due to imperfect information flows. We allow agents to revise expectations over time and we model their recursive choice among prediction strategies as an optimization problem under rational inattention. We then investigate whether a simple policy rule can steer the economy toward the targeted equilibrium. Our findings suggest that determinacy under rational expectations may not be sufficient to reach the target. Instead, monetary policy should be fine-tuned to correct agents' biased beliefs.

Fed speak on main street: Central bank communication and household expectations

Central banks emphasize the use of communication as a tool of monetary policy. As central banks increasingly recognize that low public informedness limits their ability to communicate with the general public, several have begun to explicitly tailor their communication strategies for a broader audience. Most research focuses on central bank communication with financial markets, but several recent strands of literature address aspects of communication with households. I survey the literature addressing the rationales and efficacy of central bank communication with households, supplementing this with new evidence from an assortment of consumer survey data. I draw from the literature on rational inattention, financial literacy, and political communication to suggest explanations for limited household receptiveness to central bank communications. Finally, I focus on one specific aim of central bank communication, which is to anchor inflation expectations. Previous literature finds that the announcement of an explicit inflation target helps anchor expectations among financial market participants. Using U.S. consumer survey data, I show that consumers’ expectations are imperfectly anchored and that the anchoring of more informed consumers’ expectations increased more than the anchoring of less informed consumers’ expectations following the Fed’s announcement of a 2% inflation target.

Monetary policy transmission mechanisms in Serbia: evidence from the fully-fledged inflation targeting regime

This article examines the effectiveness of monetary transmission mechanisms in the Serbian economy, covering the period from January 2009 (the point at which the formal switch to the fully-fledged inflation targeting regime was made) to December 2013. The results of the recursive VAR models suggest that the exchange rate and credit channels play a major role in the monetary transmission process, whereas this is not true in the case of the interest rate channel. However, the results of the non-recursive VAR models show that the role of the exchange rate has diminished over time. On the other hand, the credit channel has become much more influential. Thus, if one of the overriding objectives of adopting the explicit inflation targeting regime is to enhance the importance of other channels apart from the exchange rate channel, which could make monetary policy more effective in achieving price and financial stability, the switch to the inflation targeting regime is justified.

Is Inflation Target Announced by Bank Indonesia the Most Accurate Inflation Forecast?

This article investigates whether following Bank Indonesia’s explicit inflation targets (forward-looking) is a more accurate method of predicting inflation rate in Indonesia than forecast methods utilizing past information of macroeconomic data (backward-looking). The analysis is conducted by performing naive, univariate, and multivariate time-series models with an out-of-sample forecast evaluation period of January 2014–December 2016. It is found that the backward-looking approach outperforms the forward-looking approach at all forecast horizons, indicating that Bank Indonesia still does not succeed to anchor inflation expectation towards the desired level.AbstrakArtikel ini mencoba untuk meneliti apakah mengikuti target inflasi yang dikeluarkan oleh Bank Indonesia (forward-looking) adalah metode yang lebih akurat untuk memprediksi tingkat inflasi suatu periode tertentu di Indonesia ketimbang metode peramalan inflasi dengan menggunakan data informasi makroekonomi lampau (backward-looking). Analisa dilakukan dengan membandingkan model runtun waktu naif, satu peubah, dan peubah ganda dengan periode Januari 2014–Desember 2016 digunakan sebagai periode evaluasi sampel peramalan. Tulisan ini menyimpulkan bahwa performa peramalan metode backward-looking lebih unggul dari pada metode forward-looking untuk setiap jangka waktu peramalan yang mengindikasikan bahwa Bank Indonesia masih belum berhasil dalam mengendalikan ekspektasi publik terhadap inflasi ketingkat yang diinginkan.Kata kunci: Inflasi; Forward-Looking; Backward-Looking; ARMA; VARJEL classifications: C22; C32; E31; E37; E52

The Monetary Transmission Mechanism and Inflation Targeting: A Regime-Switching VAR Approach for Canada

This study employs a Markov-switching VAR with regime-dependent dynamics to assess the trans­mission mechanism of monetary policy in Canada. The regime-switching estimations divide the sam­ple period stochastically into two continuous regimes that corresponds to the periods before and after explicit-inflation targeting in Canada. The empirical results indicate relatively large differences in both the innovation process due to the variance component of the VAR and the propagation mech­anism due to the regime-dependent systematic component. The pre-targeting regime corresponds to much larger innovations in the macroeconomic variables and overall larger systematic responses of the macroeconomic variables to the innovation processes, suggesting a stronger monetary transmis­sion mechanism in the regime. However, variance decompositions and counterfactual analysis sug­gest that monetary policy has become more responsive to fluctuations in output growth and inflation in the target regime. Overall, about 80 per cent of the variations in the monetary policy rate in the current regime can be explained by the systematic reactions of policy to output growth and inflation at the relevant policy horizons.

Bayesian estimation of China's monetary policy transparency: A New Keynesian approach

By constructing a modified version of interest-rate term structure and incorporating it into a micro-founded DSGE model, this paper investigates China's monetary policy transparency as well as its macroeconomic implications by using quarterly data for the period 1992–2013. Empirical results from Bayesian estimation show that, the degree of China's monetary policy transparency is quite low. This conclusion is further confirmed by the actual practice of China's monetary policy in many aspects. From a policy perspective, a two-step monetary policy reform should be adopted by China while it moves toward a market-based macroeconomic framework. First, the independence of the central bank should be strengthened and an explicit inflation targeting regime should be adopted to make inflation under control. Second, a series of institutional arrangements should be established to increase monetary policy transparency in practice.

International long-term yields and monetary policy in a small open economy: The case of Canada

The objective of this study is to identify the impact of the recent period of international integration of bond markets on interest rates in a small open economy. The empirical methodology captures a financial globalization regime with a nonlinear, structural vector autoregression (SVAR) and a regime-switching contemporaneous interest-rate block. The responses of longer term interest-rate spreads in Canada to changes in U.S. long-term nominal interest rates are found to have increased by about one-third in the globalization regime since the late 1990s, consistent with recent research on the effects of international long-term yields on those in small open economies. There is also some evidence of a weaker response of the longer term spreads, a measure of the stance of policy in Canada, to the monetary policy rate in the globalization regime. However, the evidence does not support an important decoupling of short- and long-term interest rates that has made the monetary transmission mechanism less effective for controlling economic activity and inflation. In fact, monetary policy appears to have become even more effective in the globalization regime as result explicit inflation targeting.

Examining the Success of the Central Banks in Inflation Targeting Countries: The Dynamics of Inflation Gap and the Institutional Characteristics

This paper analyzes the performance of central banks in 27 inflation targeting countries by examining their success in achieving their explicit inflation targets. For this purpose, we decompose the inflation gap, the difference between actual inflation and inflation target, into predictable and unpredictable components. We argue that the central banks are successful if the predictable component in the inflation gap diminishes over time. The predictable component of inflation gap is measured by the conditional mean of a time-varying autoregressive model. Our results find considerable heterogeneity in the success of these IT countries in achieving their targets at the start of this policy regime. Our findings also suggest that the central banks of the IT adopting countries started targeting inflation implicitly before becoming an explicit inflation targeter. The panel data analysis suggests that the relative success of these countries in reducing the gap is influenced by their institutional characteristics particularly by fiscal discipline and macroeconomic performance.