Point targets, tolerance bands or target ranges? Inflation target types and the anchoring of inflation expectations

Abstract

Inflation targeting is implemented in different ways -most often by adopting point targets, by having tolerance bands around a point target, or by specifying target ranges. Using data for 20 economies, this paper tests whether the various target types affect the anchoring of inflation expectations at shorter horizons differently. It tests two contradictory hypotheses, namely that targets with intervals lead to (i) less anchoring, e.g. because they provide more flexibility to the central bank, or (ii) better anchoring, because they are missed less often, leading to an enhanced credibility. The evidence refutes the first hypothesis, and generally finds that target ranges or (in some cases) tolerance bands outperform the other types. However, the effects partially depend on the economic context and no target type consistently outperforms all others. This suggests that there are some benefits to adopting intervals, but the central bank can anchor inflation expectations also by other means.

How optimal is Ghana's single-digit inflation targeting? An assessment of monetary policy effectiveness in Ghana

“…Many explanations are provided. Ehrmann (2021) claims, for example, that point objectives are more likely to be missed than range targets, although Kahn and Parrish (2020) note exceptional conditions such as shocks in the price of oil. According to Albagli and Schmidt-Hebbel (2003), inflation targets would be frequently missed if institutions were weak, the central bank was not independent and risk premiums were large.…”