Shaken, not Stirred: Comparing the Effectiveness of Pure and Hybrid Inflation Targeting

Abstract

The study explores how the choice between pure and mixed (hybrid) inflation targeting affects the likelihood of achieving the announced inflation target achievement. Pure inflation targeting is deemed to be a regime under which inflation is the only variable in a central bank's objective function, while hybrid targeting is an alternative regime, which, in addition to inflation, includes the exchange rate in monetary authorities' objective function. Modeling is conducted on panel data of 32 inflation targeting countries. The cluster analysis method is applied to classify countries with respect to the regime used: pure or hybrid.Then a binary choice model of the probability of achieving the inflation target is estimated. The use of the hybrid option of inflation targeting is found to be associated with the increase in this probability, suggesting a higher effectiveness of this regime versus pure inflation targeting.

Monetary policy and the effect of the oil prices pass-through to inflation

“…In other words, regulating the foreign exchange rate as part of inflation targeting does not produce additional advantages compared with a free-floating national currency in terms of changing the pass-through effect. This, however, does not contradict the fact that this regulation may affect other monetary policy performance characteristics, as shown in Pourroy (2012), and Kartaev and Luneva (2018).…”

“…According to the approach used in Kartaev and Luneva (2018), we view pure inflation targeting as a regime where the target function for the monetary authorities only includes the deviation of inflation from the target. In this case, the central bank does not intervene in the foreign exchange market (except for emergencies) and achieves the monetary policy goal by relying on the interest channel of monetary transmission.…”

“…The classification of countries based on their type of inflation targeting regime is taken from Kartaev and Luneva (2018). The data source for foreign exchange rates and consumer price indices is International Financial Statistics.…”