Inflation Targeting Regime Research Articles

Exploring the nexus between inflation targeting and exchange market pressure: Evidence from the global financial crisis

This study investigates the effects of the inflation targeting (IT) monetary framework on the exchange market pressure index (EMPI) across 24 Asian economies from 1998 to 2018, with a particular focus on the period covering the global financial crisis (2008–2018). Employing dynamic panel data modeling and Propensity Score Matching, our analysis reveals a positive impact of implementing the IT on the EMPI. The findings suggest that adopting an IT regime effectively reduces exchange market pressure, demonstrating notable resilience following the global financial crisis of 2008. This highlights that an IT policy enhances the credibility of monetary policy, thereby decreasing the need for central bank interventions in the foreign exchange market within this framework.

Inflation targeting and monetary policy response in India

India adopted the Flexible Inflation Targeting (FIT) regime in 2016 under the mentorship of the Monetary Policy Committee (MPC). With FIT’s introduction, the effectiveness of monetary policy transmission channels required a re-visit and this paper is a valuable contribution in this direction. Using the multivariate model with an augmented Bayesian set- up, we find that FIT-MPC has strengthened the credit and interest rate channels while their impact on output has weakened. The impact of Operation Twist – a set of unconventional measures pursued during the pandemic is visible. Overall, the findings highlight the overhauling effect of monetary policy transmission in the Indian context.

Monetary policy transmission dynamics: evidence from Indian financial markets

ABSTRACT Our study employs a non-recursive Structural Vector Autoregressive Model (SVAR) to examine to how monetary policy signals transmit across the money, treasury bills, bonds, forex, and the stock market in India and in the process unravel the relative efficacy of various monetary policy signalling instruments on these financial market variables. This exercise is conducted for two distinct monetary policy regimes -Multiple Indicator Regime and Flexible Inflation Targeting Regime. Our results indicate that the transmission of monetary policy differs not only across various segments of the financial markets, but is also sensitive to the choice of monetary policy instruments used by the Reserve Bank of India (RBI) under different regimes. In a bid to heighten the efficacy of monetary policy signals it is hence suggestive that developing economies with high inflation should move towards an inflation targeting regime.

Singular spectrum analysis to estimate core inflation in Brazil

This paper presents a set of new core inflation measures for Brazil based on the Singular Spectrum Analysis (SSA) method. The measures are based on the official target used in the Brazilian inflation targeting regime. The period of analysis ranges from the beginning of the inflation targeting regime in 1999 and 2021. The SSA measures were compared to the inflation core ones used by the Central Bank of Brazil, through the evaluation of unbiasedness, short-term adjustment dynamics and predictive ability. The measures estimated by SSA meet the desired properties and have a greater predictive capacity than the other inflation cores.

How are green stocks and monetary policy related?

We propose and test the hypothesis that green stocks and monetary policies are interdependent. Using time-series data for two large economies (India and Indonesia), that have adopted inflation targeting regimes, we develop a structural vector autoregressive model of monetary policy and green stocks that combines with output. We find that green stock prices fall (rise) in response to inflation with a lagged effect and policy rate shocks for India (Indonesia). Currency depreciation, on the other hand, increases green stock prices for India but has a muted effect for Indonesia. We also discover that, for India, monetary policies hardly respond to green stock price shocks while, for Indonesia, green stock prices do influence the evolution of monetary price variables. Our main contribution is that we decipher the effects of green stocks from aggregate market shocks and show each of these market price shocks is related to the monetary aggregates.

The case for nominal GDP level targeting

AbstractIn this paper, I make the case for a nominal GDP level target in the United States. I begin by arguing that the Federal Reserve's current flexible average inflation targeting regime is deficient. I then argue that since a competitive monetary equilibrium is optimal, monetary policy should seek to replicate the competitive monetary model. Doing so resembles nominal GDP targeting. I also offer the following practical reasons why policymakers might prefer a nominal GDP target. Nominal GDP targeting (a) does not require policymakers to determine whether current economic fluctuations are demand‐driven or supply‐driven nor does it require real‐time estimates of the output gap, (b) automatically prevents the central bank from exacerbating supply shocks, and (c) leads to greater financial stability. Finally, I make the case for targeting the level, rather than the growth rate, of nominal GDP. Doing so prevents the path of nominal GDP from deviating arbitrarily far from its intended growth path, which anchors expectations and aids in long‐run economic decision‐making.

What has inflation targeting done for household consumption?

Whether households’ consumption level in an Inflation-Targeting (IT) regime, which steers inflation and its expectations, differs from that of a non-IT regime remains empirically unexplored. Using IT as a treatment and acknowledging the potential for country heterogeneity and material confounding factors, we leverage several treatment methods to study the causal, dynamic IT effect on aggregate household consumption across developed and developing countries. We find significant heterogeneous IT effects on aggregate consumption levels in two-thirds of the IT sample. The heterogeneity does not support the notion of an isomorphic average causal IT effect on household consumption across countries. The government’s willingness to meet IT policy adoption preconditions and the country’s fiscal profile are critical drives of this parameter heterogeneity in developing and developed countries. However, the central bank’s appetite for restricting exchange rate movements contributes to this heterogeneity in only developing countries. We find that macroeconomic uncertainty proxied by the inflation level, inflation variability and output growth variability are essential channels in developing countries. In addition, financial development and savings are crucial channels across development status.

Recent Developments in Indian Central Banking: Flying through Turbulence but Aided by Some Tailwinds

This paper, an extension of our earlier work, presents a narrative of select broad aspects of Indian central banking during the pandemic and thereafter. As elsewhere, Indian monetary policy during the pandemic was characterized by substantial monetary expansion both in terms of rate cuts as well as asset purchase programs. The inflation targeting regime of Indian monetary policy was put to severe stress following the spurt in inflation after the pandemic. Besides, there have been two positive developments in Indian central banking. First, there has been significant improvement in the balance sheets of the Indian banking sector, following the institution of an effective corporate bankruptcy regime, write‐offs of earlier stressed assets, and recapitalization of public sector banks by the government. Second, India has made substantial progress in terms of adopting various facets of its digital financial infrastructure, where public initiatives were accompanied by private sector innovations. The digitalization of payments increased in both quantum and value and has touched the lives of the public through the ease of making daily payments, including the smallest of transactions.

UKRAINE’S MONETARY POLICY UNDER MARTIAL LAW

The relevance of the research is due to the change in the monetary policy regime of the National Bank of Ukraine (NBU), which consists in the transition from inflation targeting with a floating exchange rate to a fixed exchange rate as the nominal anchor of monetary policy under martial law. Such a plan to change the monetary policy regime was carefully calculated and outlined in the NBU's Monetary Policy Guidelines for the Duration of Martial Law. The timeliness and effectiveness of the NBU's monetary policy decisions enabled it to mitigate the impact of the military shock on the macro-financial stability of the national economy. The purpose of the article is to consider the theoretical and practical aspects of the NBU's monetary policy under martial law. Methodology. The study uses a systematic method of cognition to determine the sequence of application of monetary policy instruments to smooth out monetary shocks of the wartime period; an abstract-logical method to understand the future monetary policy strategy based on the abandonment of the fixed exchange rate regime and a gradual return to inflation targeting; and a statistical method to analyse the dynamics of monetary indicators of the national economy. Results. The paper presents the main principles of the NBU's monetary policy under martial law. The first shock from the war led to changes in the conduct of monetary policy and a shift to unconventional instruments of its regulation. The gradual adaptation of the economy to the new conditions determined the NBU's further steps to ease monetary policy and move to greater exchange rate flexibility. Practical implications. The practical significance of the research results is to assess the conditions for the transition from the key policy rate-based inflation targeting regime as the main monetary policy instrument to the use of foreign exchange interventions as the main operation in the foreign exchange market under martial law. Value / Originality. The originality of the article is due to the need to identify the prerequisites for the transition to a new monetary policy strategy in a wartime economy. Conclusions. The NBU's timely response to the negative phenomena associated with deteriorating inflation expectations, multiple exchange rates and pressure on international reserves helped prevent the development of a currency and financial crisis in Ukraine. Despite the active hostilities, the NBU is trying to find options that will allow it to conduct an effective monetary policy in the face of a full-scale invasion and unprecedented internal and external shocks. Internationally, Ukraine has exceeded expectations and the NBU has shown a high degree of responsibility, professionalism and creativity in the conduct of monetary policy. Increased confidence in the central bank is a valuable resource in times of martial law.

Efficacy of Monetary Policy Transmission During the Flexible Inflation Targeting Regime in India

This article builds a Structural Vector Autoregressive model and employs non-recursive identification restrictions to examine the effectiveness of the Monetary policy transmission mechanism in India during the Flexible Inflation Targeting regime (2016–2023). The results indicate that policy rate shocks have a significant negative impact on domestic output and prices during this regime. The findings further, reveal evidence of an exchange rate puzzle during the Flexible Inflation Targeting regime. Our results give credence to the RBI’s move towards a Flexible indicator targeting approach as all the macroeconomic variables of interest, that is, Domestic output and inflation produce plausible estimates in response to a monetary policy shock. JEL Classification: C32, E52, E5, E52, F41

Uncertainty shocks and monetary policy rules in a small open economy

Abstract Post the great financial crisis (GFC) of 2008–2009, there has been a surge in the macroeconomics literature on aggregate uncertainty. Although the recent literature has recognized the adverse real effects of global uncertainty shocks in emerging market economies (EMEs), the role of monetary policy in offsetting these adverse effects and their link with the exchange rates is not explored in the literature. We find that the currently followed interest rate rules (IRRs) under a flexible inflation-targeting regime are ineffective in stabilizing the domestic economy during periods of high global uncertainty in the EMEs. Using a small open economy new Keynesian DSGE model with Epstein–Zin preferences and second-moment demand shocks, we compare and propose alternate monetary policy rules that significantly reduce welfare losses. We find that the best monetary policy rule in terms of welfare depends on the nature of shock that is, first-moment or second-moment shock.

The contradictions of unconventional monetary policy as a post-2008 thwarting mechanism: financial dominance, shadow banking, and inequality

The global financial crisis (GFC) of 2008 has triggered profound changes in the macro-financial regulatory architecture. Ever since, the interplay between political, institutional, and macroeconomic developments has received increasing attention in political economy, as in the evolutionary macro-financial approach of institutional super-cycles with its concept of thwarting mechanisms. While these institutional structures aim to stabilise the macro-financial system, they may also contradict each other due to unintended side effects. This paper argues that the understanding of thwarting mechanisms can be enriched by further integrating it with political economy literature on finance within the post-GFC institutional setup. It conceptualises unconventional monetary policy as a novel thwarting mechanism and analyses the contradictory implications for overall macro-financial stability with a particular focus on aggregate demand. It suggests three reasons why this thwarting mechanism failed to restore sustained economic growth in the post-crisis decade: First, sustained large-scale asset purchases perpetuate the structural drivers of financial dominance in political power relations, entrenching the role of the shadow banking system within the macro-financial order and impairing the development of other thwarting mechanisms. Second, unconventional monetary policy maintains the tenets of the inflation targeting regime and thereby sustains neoliberal macroeconomic governance with restrained fiscal policy. Third, it exacerbates preexisting wealth and income inequality by redistributing wealth towards asset owners, undermines consumer demand, and thus contributes to stagnation tendencies. Thus, this paper suggests that the contradictions of this novel post-GFC thwarting mechanism contribute to weaken economic growth and thus fail to restore macro-financial stability.

(Mis)Alignment between observed and expected monetary policy: The case of Brazil

The economic agents’ perception of the monetary policy might not coincide with the central bank conduct. We investigate this issue by using both actual and expected data identified by professional forecasters for Brazil, an emerging economy that has long adopted the inflation-targeting regime. We estimate observed, expected, and forward-looking interest rate rules, apply Full-Information Rational Expectations (FIRE) tests, assess restrictions implied by models of information rigidity, and perform several robustness checks. The estimated policy rules respond to inflation deviations and output gap according to theoretical grounds. Professional forecasters, however, do not believe in aggressiveness to fight inflation in longer forecasting horizons, while FIRE tests unveil information rigidity in the short run. There is a misalignment between the Central Bank practice and the private agents’ perception of the monetary policy in the long but not in the short run, suggesting unanchored long-term inflation expectations.

State-dependent oil price shocks on inflation and the efficacy of inflation targeting regime

This paper investigates the state-dependent effect of oil price shocks on domestic inflation using a panel of 30 countries over the period of 2001Q3 to 2022Q4. We find a significant asymmetric effect over different economic states, with a positive and significant effect during economic boom periods, while no significant effect during bust periods. Such state-dependent effect is also quantitatively verified through a dynamic panel threshold framework. As a related question, the paper also examines the effectiveness of inflation targeting (IT) regime in adjusting the oil price shocks-induced inflation. We evaluate the effectiveness of IT regime from several dimensions: whether it contributes to reducing 1) the level of inflation induced by oil price shocks during boom periods, 2) the probability of oil price shocks-induced inflation deviating from inflation target range, and 3) the duration of inflation deviations from the target range. Our findings indicate that central banks under inflation target regime do not mitigate the level and volatility of inflation induced by oil price shocks more effective than the Non-IT regime. Nevertheless, it reduces the duration of oil price shocks-induced inflation that is above the upper limit of target range. As for the causes, our findings suggest that inflation-targeting central banks do not react aggressively to oil price shocks during economic expansions so as to maintain the positive momentum of economic growth and employment, rather than immediately curbing inflation.

Inflation targeting regime in the Russian economy

Subject. This article discusses the issues related to the inflation targeting regime in the Russian economy. Objectives. The article aims to assess the impact of the inflation targeting regime on the Russian economy. Methods. For the study, I used analysis and synthesis, special economic and mathematical methods, correlation and regression analysis, and the graphical method. Results. The article covers the impact of the inflation targeting regime on the Russian economy in the context of numerous aspects and positions. It reveals that the inflation targeting regime for the Russian economy causes the depreciation of ruble liabilities, increasing the requirements for guarantees of their high profitability. Conclusions. The impact of the inflation targeting regime on the Russian economy, which is ultimately expressed in the depreciation of ruble liabilities and the devaluation of the ruble, in the context of a decrease in the gold content of the average monthly nominal accrued wages of employees in a full range of organizations, informs the authorities about the possibilities of stimulating the growth and development of the Russian economy.

Managing inflation expectations and the efficiency of monetary policy responses to energy crises

While ascertaining low and stable inflation expectations is a significant challenge across developed and emerging economies, energy shocks are central to this endeavor. Therefore, this study's prime objective is to investigate the role of energy shocks, monetary policy, and fiscal policy in managing inflation expectations in the context of the Federal Reserve's inflation targeting regime, adopted in 2012. We analyze monthly data on the United States from 1994 to 2022. Using the linear Autoregressive Distributed Lag (ARDL) and the Quantile ARDL (QARDL) estimators, we analyze and compare three different samples: full period, pre-inflation targeting regime (1994 to 2012), and post-inflation targeting regime (2012 to 2022). The conclusions suggest that inflation, energy shocks, and money supply have significant implications for inflation expectations in most quantiles during pre- and post-inflation targeting regimes. Policy implications for research and practice are also discussed.

Trust in the central bank, financial literacy, and personal beliefs

This paper examines trust in the central bank across ten Central, Eastern and Southeastern European countries, using survey data collected from 61,398 individuals. Our results show that financially literate individuals are more likely to trust central banks. The association is stronger in countries with inflation targeting and flexible exchange rates regimes. Distrust in the central bank is associated with higher inflation expectations, savings in foreign currency or a preference for cash. Even when the sample is restricted to individuals with high inflation expectations, financial literacy remains associated with greater trust in the central bank. We find that trust in the central bank correlates negatively with financial inclusion but positively with wealth. Financially literate citizens express less trust in the government, which highlights that trust in the central bank is not entirely indicative of trust in the government. However, individuals who think that prices will rise and the local currency will depreciate distrust both the central bank and the government.

A short term credibility index for central banks under inflation targeting: An application to Brazil

Our goal is to provide econometric tools that could act as an almost real-time warning-system for central banks working under an Inflation-Targeting Regime. In any given month, it computes the probability that inflation will remain within the tolerance bounds set in advance by the Regime. So, our short-term index gives a proper response time for Central Banks, something long-term indices prevalent in the literature do not provide. Although we showcase Brazil in our application, our method could be broadly applied to other countries that operate under an Inflation-Targeting Regime. Our key statistic is the probability that inflation will be within the bounds in the next 1- 3- and 6-months ahead. It is based on predictive densities obtained from a mixed causal-noncausal autoregressive (MAR) model. We polish the accuracy of our key statistic using the receiver operating characteristic curve (ROC curve), something new in this literature.

THE KEY RATE OF THE CENTRAL BANK AS A MONETARY POLICY TOOL

The article examines the theoretical and methodological foundations of the interest policy of the National Bank of Ukraine. It is noted that the accounting rate is one of the monetary instruments, with the help of which the central bank establishes for banks and other subjects of the money market a benchmark for the value of the funds raised and placed. It was determined that in the process of implementing the interest policy, the National Regulator also sets the interest rate for permanent access instruments from: absorption of excess liquidity for the overnight term (for overnight deposit certificates) at the level of the discount rate; provision of additional liquidity for the overnight term (for overnight loans) linked to the discount rate. The study also states that the interest rate channel is the main channel of the transmission mechanism, because the mechanism of its action is that a change in monetary policy through a change in the discount rate directly affects short-term rates on the financial market, and through the yield curve - on long-term rates. The importance of returning to the inflation targeting regime, choosing its eclectic type, has been proven under favorable conditions. This will make it possible to apply a double mandate: ensuring price stability and, for example, maintaining the employment of the population. After all, full-fledged inflation targeting requires a sufficient level of development of the financial market, balanced state finances, an appropriate structure of the economy (free pricing, an insignificant level of dollarization of the economy, etc.). Also, under appropriate conditions, it is necessary to restore the symmetric corridor of interest rates and return to the operational design of the interest policy, which was in effect before the introduction of martial law.

Foreign Price Shocks and Inflation Targeting: Effects on Income and Inflation Inequality

ABSTRACT Foreign price shocks have significant effects on functional income distribution and on inflation inequality. By increasing prices in domestic currency that are linked to foreign prices, they increase the profit share in some sectors and reduce real wages, in particular of workers whose consumption basket is more sensitive to the price of certain goods (e.g., food prices for low-wage workers). We propose a new extension to the conflicting-claims inflation model by incorporating workers heterogeneity (in terms of nominal income and consumption patterns) in an open economy model following an inflation-targeting regime. Then, we investigate the impacts of foreign price shocks on income and inflation inequality by increasing the foreign inflation rate and analyze how monetary policy influences these outcomes. Our simulation results indicate that a positive foreign price shock increases the profit share and the within-workers inequality (in real terms), since low-wage workers are more affected by these shocks. Yet, such effects are mediated by the strength of the monetary policy's transmission channels (domestic economic activity or nominal exchange rate), indicating that the monetary authority response may exacerbate or attenuate these distributive effects.