Inflation Targeting in Emerging Market Economies

Abstract

This paper assesses inflation targeting in emerging market economies (EMEs), and develops applied prescriptions for the conduct of monetary policy and inflation-targeting design in EMEs. We verify that EMEs have faced more acute trade-offs -higher output and inflation volatility -and worse performance than developed economies. These results stem from more pronounced external shocks, lower credibility, and lower level of development of institutions in these countries. In order to improve their performance, we recommend high levels of transparency and communication with the public and the development of more stable institutions. At an operational level, we propose a procedure that a central bank under inflation targeting can apply and communicate when facing strong supply shocks, and suggest a monitoring structure for an inflation-targeting regime under an IMF program.

Inflation targeting in emerging economies: What do the data say?

“…8 To avoid the contamination of our results by the incidence of hyperinflations, we calculate the averages of our economic variables excluding the years when inflation was above a 50% threshold. We chose to eliminate only the high inflation years instead of discarding all of the data from any given country 4 The adoption dates of the IT framework by the countries in our data set were based on Fraga et al (2003). 5 In the traditional "difs-in-difs" estimations, the first and second periods are exactly the same for the control and treatment groups.…”

Does inflation targeting make a difference in developing countries?

“…Quite a few studies in the literature (e.g., Carare and Stone, 2006;Fraga et al, 2003;Fry et al, 2000;Masson et al, 1997;Minella et al, 2003;Mishkin, 1996;Mishkin, 2004;Mishkin and Savastano, 2001;Svensson, 2002) argue that the performance of an inflation targeting regime can be affected by these idiosyncrasies. Therefore, in addition to evaluating the average treatment effects, it is also important to explore the heterogeneity feature of the effectiveness of adopting inflation targeting in developing countries.…”

Demand Shocks and Trade Balance Dynamics

“…The model extends the framework of Fraga et al (2003) and Detken and Gaspar (2003). Our model equations are derived and solved by considering that all agents, households, firms and monetary authorities, maximize their behavior.…”

“…3 When the probability of adjusting prices is one, which means that all firms change their prices at each moment (the case of full price flexibility), the aggregate supply is a line completely vertical (see, for instance, Woodford 2003, chapter 2). 4 See, for instance, Fraga et al (2003). stationary AR process: τ t = lτ t−1 + κ t .…”