Does Inflation Targeting Matter? An Experimental Investigation

Abstract

We use laboratory experiments with human subjects to test the relevance of different inflation targeting regimes. In particular and within the standard New Keynesian model, we evaluate to what extent communication of the inflation target is relevant to the success of inflation targeting. We find that if the central bank only cares about inflation stabilization, announcing the inflation target does not make a difference in terms of macroeconomic performances compared to a standard active monetary policy. However, if the central bank also cares about the stabilization of the economic activity, communicating the target helps to reduce the volatility of inflation, interest rate, and output gap although their average levels are not affected. This finding is consistent with those of the theoretical literature and provides a rationale for the adoption of a flexible inflation targeting regime.

Experiments on Macroeconomics: Methods and Applications

“…A similar issue arises in Cornand and M'baye (2018), who ask subjects to state inflation expectations, but not output expectations, although the macro-model behind the experiment requires both. As Pfajfar and Zakelj (2018) and Assenza et al (2013 in one of their treatments), Cornand and M'baye assume that firms naively expect the same level of aggregate output as realized in the previous period.…”

“…Amano et al (2011) compare how subjects form expectations when a central bank implements inflation targeting or price-level targeting. Cornand and M'baye (2018) study the role of central bank's inflation target communication by comparing treatments in which the central bank explicitly announces its inflation target to treatments in which the central bank does not announce the target. Kryvtsov and Petersen (2013) show that public announcements of interest rate forecasts are useful to shape expectations but may reduce the effectiveness of monetary policy by increasing macroeconomic fluctuations.…”

“…In fact, the backward-looking component may have reduced the impact of information about future inflation rates. Nevertheless, Cornand and M'baye (2018) observe that the explicit announcement of an inflation target affects expectations and reduces the volatility of aggregate variables. It is possible that this effect might have been even more pronounced if they would not have imposed naive expectations for the output gap.…”

“…and estimate their shares among subjects. Most subjects are trend extrapolative or adaptive, except when they have information about future variables (for example, the central bank inflation target, as in Cornand and M'baye 2018). Second, it is important to provide suitable microfoundations.…”

“…However, forward-looking rules also need to be included, because otherwise the model would not respond to information about future changes of exogenous values, which is at odds with observations in experiments. Cornand and M'baye (2018), for example, show that subjects switch less when the central bank communicates its inflation target and that subjects are less backward-looking when they receive information about future policy.…”