Determinants of inflation targeting in emerging market economies

What is it about?

This paper examines the macroeconomic, financial, and institutional factors that affect the adoption of inflation targeting vis-a-vis alternative monetary policy strategies for 44 emerging market economies during 1990-2017. Our empirical model incorporates most of the macroeconomic and institutional variables used in the empirical research in this field, such as macroeconomic performance (inflation and output growth as well as their volatilities), public debt, financial sector development, central bank independence, financial openness, trade openness, and money growth.

Featured Image

Why is it important?

Unlike the existing empirical evidence, which is generally based on binary choice models, we employ a multinomial logistic regression, with IT and exchange rate pegs as the treatment groups, and intermediary monetary strategies as the baseline group. Given that policymakers in EMEs are usually faced with a set of choices for monetary strategies, including currency pegs, IT, and intermediate regimes, the use of a multinomial instead of a binary choice model allows for a more robust modelling framework with respect to the set and complexity of available choices. Moreover, since economic theory provides only a tentative list of the main prerequisites for adopting IT, it does not preclude the possibility that these factors might be equally relevant for adopting other monetary regimes as well. In these regards, our approach can differentiate between the factors that are specific to the adoption of IT from those factors whose relevance is more general, namely those that are important for the successful implementation of any monetary strategy. We show that, besides average macroeconomic performance, macroeconomic instability (inflation and output volatility), too, matters for the adoption of inflation targeting. In these respect, macroeconomic conditions seem to have different impact on the choice of inflation targeting and exchange rate pegs, whereas similar institutional conditions are conducive to the implementation of both regimes. Finally, the effects of macroeconomic and institutional conditions do not depend on the type of inflation targeting.

Perspectives