Evaluating inflation targeting based on the distribution of inflation and inflation volatility

Mzwandile Ginindza and Esfandiar Maasoumi

The North American Journal of Economics and Finance, 2013, vol. 26, issue C, 497-518

Abstract: In this paper the Financial Development Index (FDI) is used to rank 57 of the world's leading financial systems. Its calculation is based on the following 7 economic pillars: (1) Institutional environment, (2) Business environment, (3) Financial stability, (4) Banking financial services, (5) Non-banking financial services, (6) Financial markets, and (7) Financial access. Pillar (4) is constructed from bond markets, stock markets, foreign exchange markets, and derivative markets. Pillar (5) includes a country's IPO activity, namely the IPO market share, IPO proceeds amount, and IPOs share of world IPOs. The stock market index provides a short-term account of financial activities, whereas the FDI provides a long-term broader account of the financial structure and health of an economy. As the performance and success of a given monetary policy would less likely be judged on short-term dynamics, it seems sensible to use the annual FDI as one of several economic and country attributes in a policy evaluation of Inflation Targeting. The paper offers a potential outcomes analysis of the impact of inflation targeting on inflation and inflation volatility, and focuses on advanced economies that adopt “inflation targeting” as a formal monetary policy. In order to deal with the counterfactual question, namely what would be the inflation rate for an adopting country had it not adopted this policy, the paper offers a new matching technique that subsumes the traditional propensity scores methods as a special case. The paper has different proposals for assessing “matching” based on the whole distribution of any “scores”. Additionally, the paper goes beyond the Average Treatment Effect (ATE) and examines the entire distribution of inflation and its “variability”. It is found that the adoption of inflation targeting has helped lower inflation (not just the mean) for the targeting countries. However, it is shown that exact numerical quantification of this policy effect is as highly subjective as choosing ideal social welfare functions. The paper also finds no evidence of a larger gain for “late adopters” of inflation targeting. As for inflation variability, there is some robust evidence of small and often statistically insignificant reduction in variability due to targeting.

Keywords: Inflation targeting; Financial indicators; Policy evaluation; Matching; Aggregate indices; Treatment; Monetary policy; Federal reserve; Distributed effects (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:26:y:2013:i:c:p:497-518

DOI: 10.1016/j.najef.2013.02.018

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