Assessing inflation targeting after a decade of world experience

Abstract

Ten years of inflation targeting worldwide provide valuable lessons. Inflation targeters (ITers) have been very successfulin meeting their inflation targets (ITs). Industrial output sacrifice during inflation stabilization and industrial outputvolatility has frequently been lowered after IT adoption. ITers have consistently reduced inflation forecast errors afterIT adoption. The influence of price and output shocks on the behaviour of inflation and output gaps has changed muchmore strongly among ITers than in non-targeting industrial countries in the course of the 1990s. IT has played a role instrengthening the effect of forward-looking expectations on inflation, hence weakening the weight of past inflationinertia. Central bankers’ aversion to inflation is, on average, not different among ITers in comparison to NITers but hasrisen in emerging-country ITers. ITers have gradually reaped a credibility gain, allowing them to achieve their targetswith smaller changes in interest rates in the late 1990s than the changes that were required in the early 1990

Does Inflation Targeting Matter?

“…Thus, rather than being a product of the IT regime, the rise in inflation aversion may just reflect the general culture among central bankers in a decade that provided an environment conducive to price stability and, therefore, an opportunity to move away from the inflationary policies of the 1970s and 1980s. Corbo, Landerretche Moreno, and SchmidtHebbel (2001) build on this study and show that inflation aversion increased during the 1990s among IT countries that do not belong to the group of industrialized economies, most notably Israel and Chile. Among industrialized countries, inflation targeters do not show an increase in inflation aversion.…”

Inflation Targeting: Assessing the Evidence

“…This author controls for past level and variability of inflation, finding that neither the variability of expected inflation nor the average absolute forecast error present significant additional reductions, beyond the effect through the drop in inflation. By contrast, Corbo et al (2001) finds that IT has reduced inflation uncertainty and inflation forecast errors towards the low level prevalent in non-targeting industrial countries.…”

“…Later studies Corbo et al, 2001Corbo et al, , 2002Clifton et al, 2001;Arestis et al, 2002;Johnson, 2002Johnson, , 2003Neumann and von Hagen, 2002;Scott and Stone, 2005) inevitably afforded longer periods and more data. Overall, this evidence supports the contention that IT matters.…”

“…They also estimate Phillips curves for the periods before and after IT, rejecting the hypothesis of instability in the parameters estimated for these functions. Corbo et al (2001) calculate the sacrifice ratios as the cumulative GDP variation to a trend utilizing the Hodrick-Prescott filter, divided by the corresponding inflation change in any period. Inflation targeting improvements are registered with important decreases in sacrifice ratios in Canada, Australia and the UK, but also a relevant deterioration is reported in New Zealand and Sweden.…”

“…150). Cecchetti and Ehrmann (1999) and Corbo et al (2001) also assess changes in central bank aversion to inflation, delivering mixed results. Cecchetti and Ehrmann (1999) find that, where an increase in central bank aversion to inflation is apparent, both for IT countries and non-IT countries, it is within the group of IT countries that it has increased the most.…”