Does Inflation Targeting Improve Fiscal Discipline? An Empirical Investigation

René Tapsoba

No 201020, Working Papers from CERDI

Abstract: Based on panel data of 58 countries, of which 22 Inflation Targeters and 36 non Inflation Targeters, over the period 1980-2003, this paper highlights the effect of Inflation Targeting – IT- on Fiscal Discipline –FD-. We make four contributions to the literature. Firstly, by applying the 2SLS on the data, we estimate the effect of IT on central government FD as measured by Structural Primary Fiscal Balances. Secondly, we found that the effect of IT on FD takes place only on the Developing Countries sub-sample. Thirdly, the positive effect of IT on FD is stronger when the Central Bank –CB- adopts “Partial” IT rather than Full-Fledged IT –FFIT-. Fourthly, the positive effect of IT on FD is heterogeneous: it is conditional to the degree of CB independence, the level of financial deepening, the instability in the terms of trade and the length of exposure to IT -the effect is not immediate but cumulative over time-. Our results are robust to alternative specifications - using Propensity Score Matching Method, "System GMM" estimator, LAD estimator and applying 2SLS on annual data rather than triennial averages data- Our results could contribute importantly to the debate about the relevance of IT adoption by Developing Countries -due to their bad fiscal stances-.The results suggest that these countries could successfully adopt IT and improve their fiscal stances, provided that they adopt it gradually, establish flexible framework allowing them to react temporally to short-term external shocks and accompanies it with a greater independence of their CB and a deepening of their financial systems.

Keywords: Inflation Targeting; Fiscal Discipline; Central Bank; Monetary Policy; Fiscal Policy; Public Debt Monetization; Developing Countries. (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 E63 (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Working Paper: Does Inflation Targeting Improve Fiscal Discipline? An Empirical Investigation (2011)
Working Paper: Does Inflation Targeting Improve Fiscal Discipline? An Empirical Investigation (2011)
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