GHENT UNIVERSITY

FACULTY OF ECONOMICS AND BUSINESS ADMINISTRATION

ACADEMIC YEAR 2010 – 2011

DOES INFLATION TARGETING MATTER IN EMERGING MARKET ECONOMIES?

How do emerging market economies which apply an inflation targeting framework, perform in comparison to similar economies which don’t apply inflation targeting?

Master's dissertation submitted to obtain the degree of Master in Economics

Felix Braeckman

under the guidance of

Prof. Dr. G. Peersman

PERMISSION

The author declares that the content of this master's dissertation can be consulted and/or reproduced, provided the source is acknowledged.

Felix Braeckman

GHENT UNIVERSITY

FACULTY OF ECONOMICS AND BUSINESS ADMINISTRATION

ACADEMIC YEAR 2010 – 2011

DOES INFLATION TARGETING MATTER IN EMERGING MARKET ECONOMIES?

How do emerging market economies which apply an inflation targeting framework, perform in comparison to similar economies which don’t apply inflation targeting?

Master's dissertation submitted to obtain the degree of Master in Economics

Felix Braeckman

under the guidance of

Prof. Dr. G. Peersman

I

Nederlandse Samenvatting:

HEEFT INFLATION TARGETING EEN INVLOED IN OPKOMENDE ECONOMIEËN?

Sinds enkele jaren bestaat er een nieuw alternatief op het vlak van monetair beleid: Inflation targeting. Het regime wordt gekenmerkt door volgende eigenschappen:

i. De publieke aankondiging van doelwaarde voor inflatie, numeriek uitgedrukt en op middellange termijn,

ii. een institutionele focus op prijsstabiliteit als de primaire doelstelling van het monetair beleid, iii. het gebruik van meerdere variabelen bij het bepalen van het beleid, iv. verhoogde transparantie inzake monetair beleid, en v. verhoogde aansprakelijkheid van centrale banken inzake het halen van de doelstellingen voor

inflatie. (Mishkin, 2004)

Centrale banken hopen via inflation targeting inflatie verwachtingen te ankeren aan de inflatie doelstelling, hiervoor is de geloofwaardigheid van het monetair beleid echter van enorm belang.

Het aantal landen dat besloot om het regime over te nemen steeg gestaag sinds het regime voor het eerst werd geïmplementeerd in 1989 door Nieuw Zeeland. Vandaag maken 25 landen, waarvan het merendeel opkomende economieën, expliciet gebruik van dit systeem. Ondanks het groeiende belang van de opkomende economieën op globale marketen, is onderzoek betreffende het effect van inflation targeting in deze landen echter schaars, in tegenstelling tot het onderzoek voor ontwikkelde economieën. Het doortrekken van conclusies voor ontwikkelde economieën naar opkomende economieën zou echter niet verenigbaar zijn met de werkelijkheid. Opkomende economieën ervaren namelijk verschillende problemen en fundamenten dan ontwikkelde economieën, hierdoor is het redelijk om te veronderstellen dat in beide groepen inflatie een verschillende dynamiek kent en monetair beleid andere reacties uitlokt.

Deze studie onderzoekt welke effecten inflation targeting heeft in de opkomende economieën. Er wordt zowel gebruik gemaakt van de methode uit Ball en Sheridan (2005) als uit Pétursson (2004) om na te gaan of inflatie, inflatie volatiliteit, inflatie persistentie, economische groei en groeivolatiliteit zijn gewijzigd sinds het inflation targeting regime werd overgenomen. De keuze om twee verschillende methodes toe te passen komt voort uit verschillende redenen. Ten eerste controleert elke methode voor een specifiek fenomeen welke de data vertekenen, namelijk een selectie bias bij de keuze voor het regime, en de globale daling van inflatie en inflatie volatiliteit. Ten tweede wordt de methode van Ball en Sheridan (2005) wijd gebruikt, waardoor resultaten gemakkelijk te vergelijken zijn met andere studies. Ten derde biedt de panel data methode van Pétursson (2004) ons de kans om de tijdsdimensie van de data ten volle te benutten. Daarenboven is, dankzij de panel data, het aantal observatie zo hoog dat verschillende steekproeven kunnen worden genomen. Ten laatste kunnen we dankzij de twee methodes het effect van inflation targeting op alle vijf de bovengenoemde variabelen schatten.

De resultaten wijzen er op dat inflation targeting wel degelijk een rol heeft gespeeld in het verminderen van de inflatie, inflatie volatiliteit en inflatie persistentie. We vinden echter dat de schattingen voor de Pétursson (2004) methode slechts significant zijn voor landen met historisch middelhoge inflatie. Landen met historisch hoge of lage inflatie kennen echter geen significant effect. Dit doet er toe vermoeden dat inflation targeting enkel voordelig is indien de institutionele kwaliteit van een land zich tussen bepaalde marges bevindt.

II

De resultaten betreffende groei zijn minder duidelijk. Ten eerste werd er geen bewijs gevonden voor de bewering dat onder inflation targeting groeivolatiliteit zou toenemen. Betreffende economische groei werden er echter wel significant negatieve effecten gevonden, deze wijzen er op dat inflation targeting schadelijk is voor de groei. Dit is echter niet verbazend. Het regime kende namelijk reeds een goede reputatie inzake het initiëren van desinflatie, waardoor veel landen het regime overnamen om hun hoge inflatiecijfers te drukken. Desinflatie gaat echter meestal gepaard met een dalende of zelfs negatieve groei. Eenmaal deze desinflatie achter de rug is zou de groei zich weer moeten herstellen. Door het beperkt aantal jaren die ons ter beschikking staan kan het positieve effect van de stabielere economische omgeving echter nog niet volledig tot zijn recht komen. Het lijkt echter dat na desinflatie inflation targeting wel degelijk een positief effect kent op groei. Voor de steekproef welke bestaat uit landen die inflation targeting pas invoerde na desinflatie, is het effect van het regime op groei namelijk significant positief.

Al bij al lijkt het erop dat inflation targeting wel degelijk leidde tot een betere economische omgeving van de opkomende economieën, dit is daarom niet noodzakelijk de enige oorzaak. Meer onderzoek gericht op de ervaringen van opkomende economieën is zonder twijfel noodzakelijk om een beter inzicht te krijgen in het effect van inflation targeting. Dergelijk onderzoek zou cruciaal kunnen blijken in de verdere economische en sociale ontwikkeling van de opkomende economieën.

III

CONTENTS HEEFT INFLATION TARGETING EEN EFFECT IN OPKOMENDE ECONOMIEËN? ............. ... I

CONTENTS ............................................................................................................................... III

LIST OF FIGURES ..................................................................................................................... IV

LIST OF TABLES .................................... ................................................................................... V

INTRODUCTION ......................................................................................................................... 1

INFLATION TARGETING: A STORY OF INSTITUTIONS ...... .................................................... 2 I. Policy transmission and institutional framework ....................................................................................... 2

II. Advantages over other monetary regimes ................................................................................................. 3

III. Durability of inflation targeting .................................................................................................................. 4

IV. Criticism and preconditions for adoptation ............................................................................................... 4

ARE EMERGING MARKET ECONOMIES DIFFERENT? .......... ................................................. 6 I. What are emerging market economies? .................................................................................................... 6

II. Which emerging markets target? ............................................................................................................... 7

III. Special issues regarding emerging market economies .............................................................................. 7

IV. Summing up why emerging markets are different................................................................................... 10

DOES INFLATION TARGETING MATTER IN EMERGING MARKET ECONOMIES? ............. 11 I. Stylized facts ............................................................................................................................................. 11

II. Literary overview ...................................................................................................................................... 13

i. Research for industrial economies ...................................................................... 14

ii. Research including both industrial and emerging economies ............................ 14

iii. Research for emerging economies ...................................................................... 16

III. Empirical study .......................................................................................................................................... 21

a. The difference-in-difference approach of Ball and Sheridan (2005) ........................................... 21

i. Data .................................................................................................................... 23

ii. Inflation ............................................................................................................... 23

iii. Output growth .................................................................................................... 24

b. Panel data estimation of Pétursson (2004) ................................................................................. 26

i. Inflation ............................................................................................................... 26

ii. Inflation persistence ............................................................................................ 27

iii. Output growth .................................................................................................... 29

IV. Summary of results .................................................................................................................................... 31

CONLUSION ............................................................................................................................. 33

REFERENCES .......................................................................................................................... 34

APPENDIX ................................................................................................................................ 38

IV

LIST OF FIGURES Figure 1: Number of countries with an inflation targeting regime installed per year ..................................38

Figure 2: Percentage of global production per country ..............................................................................38

Figure 3: Percentage of global population per country ..............................................................................39

Figure 4: Import and export as percentage of GDP for industrial countries ................................................39

Figure 5: Import and export as percentage of GDP for emerging markets ................................................40

Figure 6: Average inflation rate 5 years before adoptation of the inflation targeting regime compared to the average inflation rate during the same period in non-inflation targeting emerging economies ..................40

Figure 7: Average growth rate 5 years before adoptation of the inflation targeting regime compared to the average growth rate during the same period in non-inflation targeting emerging economies. ...................41

Figure 8: Evolution average Inflation rates of inflation targeting and non-inflation targeting industrial and emerging countries ......................................................................................................................................42

Figure 9: Evolution average GDP growth rate of inflation targeting and non-inflation targeting industrial and emerging countries ...............................................................................................................................43

Figure 10: Box-plot average inflation ten years before, five years before and after the adoptation of an inflation targeting regime. ...........................................................................................................................44

Figure 11: Box-plot inflation volatility ten years before, five years before and after the adoptation of an inflation targeting regime. ...........................................................................................................................45

Figure 12: Box-plot GDP annual growth ten years before, five years before and after the adoptation of an inflation targeting regime. ...........................................................................................................................46

Figure 13: Box-plot GDP annual growth volatility ten years before, five years before and after the adoptation of an inflation targeting regime. ................................................................................................47

Figure 14: Average historical inflation rates and inflation targets in emerging economies .........................48

V

LIST OF TABLES

Table A: Overview of inflation targeting research for industrial countries ...................................................15

Table B: Overview of inflation targeting research for industrial and emerging countries ............................17

Table C: Overview of inflation targeting research for emerging economies ...............................................20

Table D: Estimation coefficients equation (4) for X representing average inflation, episodes of hyperinflation have been reduced to 50% ...................................................................................................23

Table E: Estimation coefficients equation (4) for X representing inflation volatility, episodes of hyperinflation have been reduced to 50% ...................................................................................................24

Table F: Estimation coefficients equation (4) for X representing average output growth ...........................25

Table G: Estimation coefficients equation (4) for X representing output growth volatility ...........................25

Table H: Estimates for coefficients equations (5) and (6), adjusted for hyperinflation .................................28

Table I: Estimates for coefficients equation (7) ............................................................................................29

Table J: Estimates for coefficients equations (8) and (9) .............................................................................30

Table K: Results of the above estimation. In case of more than one significant result over different samples the average was taken of all significant results .............................................................................31

Table L: Results of other studies with an emerging market sample ............................................................31

Table 1: : Starting date of inflation targeting framework in emerging market economies. ...........................52

Table 2: Figures regarding deviations from the inflation target ...................................................................53

Table 3: sample periods for estimates method Ball and Sheridan (2005) ..................................................54

Table 4: Average inflation rates for different periods of both inflation targeting and non-inflation targeting emerging markets ........................................................................................................................................55

Table 5: Average inflation rates for different periods of both inflation targeting and non-inflation targeting emerging markets with periods of hyperinflation normalized to 50%. ..........................................................56

Table 6: Average inflation volatility for different periods of both inflation targeting and non-inflation targeting emerging markets. .........................................................................................................................57

Table 7: Average inflation volatility for different periods of both inflation targeting and non-inflation targeting emerging markets with periods of hyperinflation normalized to 50% ............................................58

Table 8: Average output growth for different periods of both inflation targeting and non-inflation targeting emerging markets. ........................................................................................................................................59

Table 9: Average output growth volatility for different periods of both inflation targeting and non-inflation targeting emerging markets .........................................................................................................................60

Table 10: Estimates for coefficients equation (5) and (6) without adjusting for hyperinflation .....................61

1

INTRODUCTION

Since the adoptation of New Zealand in 1989, the inflation targeting framework has been around as an alternative to other monetary regimes. In the last two decades the regime has received a large number of followers, the majority of which are emerging market economies. Although research regarding inflation targeting is vast, only a very limited amount of them focus on the specific experience and effect in emerging market economies. The lack of such research is remarkable when observing emerging markets’ continuous growing importance in both global production and global population. This paper will attempt to formulate one of the first assessments regarding inflation targeting for a sample group solely consisting out of emerging market economies. In addition this study is one of the first to include figures from the recent Great Recession and the rise in global food prices preceding it, which was the first substantial episode of global economic turmoil that the inflation targeting framework had to endure, challenging the survival of the regime.

In the course of this paper the effect of inflation targeting on inflation, inflation volatility, inflation persistence, output growth and output growth volatility will be discussed through the use of two separate approaches. These approaches are based on the methodology used in Ball and Sheridan (2005) and in Pétursson (2004).

The rest of the paper is structured as follows. The first section will discuss the inflation targeting framework itself, looking at its characteristics, theoretical background, advantages and criticism. In the second part the differences between emerging and industrial markets will be discussed by looking at the economic environment in the light of monetary policy. Through this an argument will be made supporting an approach focused on emerging markets separately. A third section will report the empirical evidence. An overview of the stylized facts and the stance of the literature will be given, followed by two approaches applied to the dataset. Finally, the fourth section concludes. Tables and figures are all reported in the appendix, except for tables labelled with a letter (tables A to L) which are imbedded in the text.

2

INFLATION TARGETING: A STORY OF INSTITUTIONS

The amount of countries adopting the inflation targeting regime has been growing steadily over the last 20 years as can be seen in figure 1. Today 25 countries1 explicitly adopt an inflation targeting regime, of which the country of Ghana was the last one in 2007. Furthermore many consider other central banks to be implicit inflation targeters2, the European Central Bank and the Swiss National Bank are often named in this context. In order to give a clear view on what inflation targeting actually entails a short description of the regime will be given followed by a closer look at the advantages of the inflation targeting over other regime. Then the durability of the regime will be discussed after which some criticism will be expanded on. For further insight see Mishkin (2007), Bernanke and Woodford (2005), Debelle (1997), IMF (2005) and Schaechter, Stone and Zelmer (2000).

I. Policy transmission and institutional framework

Mishkin (2004) lists five crucial aspects of an inflation targeting framework:

i. The public announcement of medium-term numerical targets for inflation, ii. an institutional commitment to price stability as the primary goal of monetary policy, iii. an information-inclusive strategy to set policy instruments, iv. increased transparency of the monetary policy strategy, and v. increased accountability of central bank for attaining its inflation objectives.

An inflation targeting regime tries to achieve its target through its use of the nominal interest rate as a policy instrument3. Theoretically the main achievement of an inflation targeting regime would be that it anchors (long run) inflation expectations, which influences price- and wage-setting behaviour, such that, when an exogenous shock on inflation occurs, economic agents won’t anticipate equal or higher inflation in the future, but rather recognise that inflation will be brought down. In order to anchor these expectations a central bank needs to enjoy a certain degree of credibility which should stem from the framework inflation targeting brings with it.

The inflation target is generally set on the medium term, implying that in the short run bankers might deviate from the target in order to pursue other objectives, such as the exchange rate or monetary targets. Moreover, due to the various sources inflation might have, monetary authorities can keep a variety of indicators in mind when making policy decision. A substantial or persistent missing of the targets, on the other hand, can be penalized through the increased accountability. This accountability comes first of all from the numerical objective which gives a benchmark to the public against which to evaluate monetary policy. Secondly, accountability is generally assured trough an obligatory communication towards political authorities when inflation targets are substantially or repeatedly violated. Finally through an increased

1 Australia, Brazil, Canada, Chile, Colombia, Czech Republic, Ghana, Hungary, Iceland, Indonesia, Israel, Japan, Mexico, New Zealand, Norway, Peru, Philippines, Poland, Romania, Slovakia, South Africa, South Korea, Spain, Sweden, Switzerland, Thailand, Turkey and the United Kingdom. 2 “[Implicit inflation targeters] have so much credibility that they can maintain low and stable inflation without full transparency and accountability with respect to an inflation target. Their record of low and stable inflation and high degree of financial stability affords them the flexibility to pursue the objective of output stabilization, as well as price stability.” (Carare and Stone, 2005: 2) 3 “The general rule is to increase the nominal interest rate more than proportionally to any expected rise in the inflation rate above the target, so that the real interest rate increases. The higher real interest rate reduces aggregate demand and slows economic activity. This forces firms to lower prices in order to avoid excess supply, mitigating inflationary pressures in the economy.” (Divino, 2009: 2)

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transparency4 central bankers must justify their actions towards the broader public. The independence, on the other hand, is safeguarded through giving the central bank the sole responsibility of achieving its target, as well as through a free choice of how to reach that target. The framework of an inflation targeting regime is often coined as a framework of “constrained discretion”, in other words a framework in which the central bank has to explain what it is doing and why it is choosing to do so. Through this system of checks and balances a monetary institution should gain credibility thanks to its sound economic judgement and be perceived as professional. From this it must be clear that inflation targeting is much more than putting forward a mere target or a policy rule, it involves an institutional commitment towards creating a credible, accountable, transparent and professional monetary authority.

II. Advantages over other monetary regimes

The two main alternatives to an inflation targeting regime are monetary targeting and exchange rate targeting. Monetary targeting strives to hit pre-set targets of a certain monetary aggregate’s growth rate, and is based on the relationship between growth of money and inflation. Besides being relatively simple, it enforces fiscal discipline, the data needed is easily accessible and relationship with inflation might be clearer, wherefore easier to control. However, it might find it difficult to anchor inflation expectations5, in addition the relationship between money and inflation might not be as clear as theory would suggest, nor does the central bank have complete control over the money supply. In an exchange rate regime the central bank has the sole task is to maintain the value of the domestic money in terms of another country or group of countries, thereby “adopting” the monetary policy of another country and, if it’s lucky, inheriting its credibility. The main disadvantage, however, is that, because it is completely reliable on the monetary policy of another country, reacting to domestic economic shocks is impossible6.

According to the theoretical background inflation targeting should have several advantages over alternative monetary regimes. First of all it would enable monetary authorities to focus on the domestic economy, in contrast to an outward focus when looking at an exchange rate peg. This is especially important in emerging market economies for they are subject to much bigger domestic shocks, as argued by Fraga, Goldfajn and Minella (2003). Secondly it offers central bankers a great array of information to decide on the most adequate policy action, rather than just looking at the relation between money and inflation, as in a monetary targeting framework. Another key benefit which aids its objective of a transparent policy is the fact that the framework itself is easily understood by the public, enforcing its capability to influence inflation expectations. Fourthly ‘inflation targeting also has the potential to reduce the likelihood that the central bank will fall into the time-inconsistency trap. Because the source of time-inconsistency is often found in (covert or open) political pressure on the central bank to undertake overly expansionary monetary policy, inflation targeting has the advantage of focusing the political debate on what a central bank can do in the long-run (i.e. control inflation) rather than what it cannot do (raise output, lower unemployment, increase external competitiveness) through monetary policy’. 7 Although this advantage applies to any independent central bank, the benefit of inflation targeting in this case is that it

4 Generally through a wide publication of its intentions, internal decision process and inflation reports, or through press conferences. 5 Setting an inflation target, besides the money targets, introduces a second numerical target for inflation which might not be as successful in anchoring inflation expectations as a single inflation target might. The dual target might obscure the central bank’s objectives, making it less transparent towards the public which target should be used as a reference. 6 Further exchange rate targets can subject the central bank to speculative attacks and in extreme cases force a parity change that might not have been necessary on fundamental grounds. In addition they can encourage unhedged currency mismatches, implying that successful speculative attacks are often followed by financial and banking crises and debt defaults. Finally the burden of achieving the proper real exchange rate falls entirely on the level of domestic prices, and this is particularly costly in terms of output when prices are sticky. (IMF 2005: 166) 7 Mishkin (2000: 105)

4

forces nations to create independent central banks in order to achieve a transparent monetary policy which maintains its focus on price stability. A fifth advantage is the lower cost of failure to meet the inflation target. ‘The output costs of policy failure under some alternative monetary commitments, like exchange rate pegs, can be very large, usually involving massive reserve losses, high inflation, financial and banking crises, and possibly debt defaults. In contrast, the output costs of a failure to meet the inflation target are limited to temporarily higher-than-target inflation and temporarily slower growth, as interest rates are raised to bring inflation back to target.’8 Finally inflation targeting might be desirable for political rather than economic reasons as argued by Bernanke et al. (1999: 333). Creating a more transparent institution independent from short term political decisions, while at the same time maintaining its accountability towards the public aligns the role of a central bank with the fundamentals of a democracy and enforces its credibility as an institution.

III. Durability of inflation targeting

Since the downfall of the Bretton Woods system countries have desperately been looking for a stable monetary framework. Exchange rate regimes and monetary targeting were omnipresent during the post-Bretton Woods era but didn’t seem to be a match against the ravages of time. Rose (2007) finds that an exchange rate regime would generally remain between 6 to 8 years9 while the average inflation targeting regime is already active for about 13 years, which is about as long as the Bretton Woods system existed10. Moreover none of the countries who ever adopted the regime have yet been forced to abandon the regime11. In case one would wonder: durability does matter. Mihov and Rose (2008) showed that older monetary regimes generally experience lower inflation and more durable growth thanks to a more stable macroeconomic environment.

At the end it seems that inflation targeting offers a durable alternative to other more volatile regimes. This durability might give emerging markets an important incentive to adopt the regime and leave the more fragile frameworks behind them.

IV. Criticism and preconditions for adoptation

Critics of inflation targeting argue that inflation targeting creates lower and less stable growth. Because central bankers need to build credibility in order to anchor inflation expectations, too much emphasize might be put on stable and low inflation. Trying to reach this low and stable inflation at any cost might harm growth and its stability. Furthermore, many criticize the discretion contained in the framework. Some claim that the framework’s discretion goes too far, especially for countries lacking a history of responsible monetary policy. Others claim that the system imposes too stringent rules on inflation, not giving authorities enough discretion to react to unforeseen circumstances. Another point of criticism is the fact that inflation targeting can only account for weak central bank accountability, because inflation is hard to control and long lags may exist from the policy instrument to the inflation outcome. Additionally it is said that inflation targeting can’t prevent fiscal dominance, nor can it assure stable exchange rates.

Unsurprisingly, these critiques have been under heavy criticism themselves12. The claims regarding growth and exchange rate flexibility have been countered by empirical studies which will be discussed further down. The observation that inflation targeters experience lower growth has some grounds though.

8 IMF (2005: 163) 9 Although averages hide great variation among regimes. 10 “[The Bretton Woods system started in] January 1959 (when European currencies became convertible for current account transactions) through the crisis of August 1971.” (Rose 2007: 666) 11 Finland and Spain chose to abandon the system in 1999 when they entered the European Monetary Union. 12 Especially in Mishkin (1999), Bernanke et al. (1999) and Mishkin (2000).

5

The regime is generally adopted during or before periods of disinflation, which are generally associated with below-normal output. ‘Once low inflation levels have been achieved, however, output and employment return to levels at least as high as they were previously. A conservative conclusion is that, once, low inflation is achieved, inflation targeting is not harmful to the real economy. Given the strong economic growth after disinflation was achieved in many countries that have adopted inflation targets, a case can even be made that inflation targeting promotes real economic growth in addition to controlling inflation.’13 On the subject of discretion Mishkin (1999) argues that inflation targeting doesn’t imply any stringent rule because the target is set on the medium term, thus a large degree of discretion is allowed to central bankers on the short run, as discussed above.

Divino (2009) supports the claims of Mishkin regarding output growth. ‘On the real side of the economy, the consequences of an inflation targeting regime might be twofold, especially for developing and emerging countries that already face structural deficiencies and that have long sought price stability. Inflation might successfully be brought close to the target rate, but at a high cost in terms of unemployment, the output gap and economic growth. On the other hand, the price stability achieved by a successful inflation targeting regime might lessen uncertainty and create a favourable economic environment for investment, consumption and growth.’14

In order to solve the problem of irresponsible discretion of central banks, weak accountability and fiscal dominance many authors15 have argued that a set of preconditions are needed when adopting inflation targeting. Mishkin (2007: 348) argues that any country wishing to adopt inflation targeting must tackle some key issues and meet certain requirements. These requirements are: a) Strong fiscal policy; b) a well-understood transmission mechanism between monetary policy instruments and inflation; c) strong financial system; d) central bank independence and priority for price stability; e) the capability to forecast inflation accurately; f) no other nominal anchors than inflation; and g) a transparent and accountable central bank. Amato and Gerlach (2002) add that an inflation targeter should also be resilient to fluctuations in the exchange rate, for monetary policies under inflation targeting is no longer charged with maintaining the exchange rate. ‘Overall, the evidence indicates that no inflation targeter had these preconditions in place before adopting inflation targeting, although — unsurprisingly — industrial targeters were generally in better shape than emerging market inflation targeters at least in some dimension.’16 Whether or not these preconditions are met doesn’t seem to be crucial, the degree to which these preconditions are met are crucially more important though.

A more recent critique due to Anna Schwartz, in Romer (2006: 532), claims that inflation targeting is merely a form of conservative window dressing. In this view the public announcement of the decision to aim for lower inflation and to put more emphasize on the behaviour of inflation contributed more than the actual corresponding efforts to control inflation (such as formal targets or inflation reports). Romer (2006) refers to the “just do it” approach of the Federal Reserve which, according to him, has been as successful at keeping inflation low as inflation targeting. Further Stiglitz (2008) argues that inflation in inflation targeting countries is mostly imported from global prices. Changing domestic nominal interest rates won’t affect international prices, therefore inflation in these open economies can’t be controlled by inflation targeting.

13 Mishkin (1999: 25) 14 Divino (2009:2) 15 Among which Mishkin (2002), Amato and Gerlach (2002) and Batini and Laxton (2007). 16 Batini and Laxton (2007: 487)

6

ARE EMERGING MARKET ECONOMIES DIFFERENT?

As already mentioned before, most of the literature regarding whether or not inflation targeting mattered, has focused on industrial countries, or has bulked both industrial and emerging countries together. Such an approach however might not give a correct picture because emerging market economies might have different fundamentals, and therefore experience different inflation dynamics. In what follows the term emerging market economy will be defined, after which some fundamental issues regarding monetary policy, and economic policy in general, will be discussed.

I. What are emerging market economies?

Nowadays the term emerging market economy is a commonly used one, referring to economies which are undergoing rapid economic progress, often preceded or accompanied by political and institutional change favouring liberalization and free-market reform. According to The Economist17 the term was first coined by Antoine van Agtmael who in 1981 developed a “Third-World Equity Fund”, he came up with the term emerging market economy in order to distinguish his fund from the least developed and stagnated economies of the third-world. Thirty years later this term is still in use and a large variety of countries is now being referred to as “emerging”, while others have even managed surpass this label and continued to being fully developed economies18.

Because of the dynamic nature of the term emerging economy (“emerging” referring to a stage in development, not a state-of-being) finding a consensus regarding the countries that should be perceived as emerging economies might prove to be very hard. This is being made even more difficult because none of the renowned international institutions uses an emerging market category.19 Any grouping made in this respect therefore implies a certain degree of arbitrariness regarding its composition. Finally a group containing 15 inflation targeters20 and 16 non-targeters21 was defined, based on the country sample of one of the only studies solely focussing on emerging economies (Gonçalves and Salles, 2006) and of several equity indices regarding emerging market economies22.

This group of emerging markets represents a bit over 20 per cent of global gross domestic product (GDP) as can be seen in figure 2, of which most is produced in the non-inflation targeting countries. In contrast to their share in global GDP, they represent over 60 per cent of the global population. About 17 per cent of the global population lives in a country which explicitly target inflation as can be seen in figure 3. The relative importance of emerging market inflation targeters over industrial inflation targeters, as can be seen in both figures 2 and 3, makes it even more remarkable that most of the attention has gone to the effect of inflation targeting in industrial economies.

17

Ins and Outs: Acronyms BRIC out all over, 2008, The Economist, Vol. 388, Issue 8598, 10. 18 Such as Singapore and South Korea. 19 The United Nations distinguishes between “developed” and “underdeveloped” nations. Their Statistics Division remarks though that there is no existing convention regarding the criteria of each group. The World Trade Organization employs equal categories as the UN, but here members can decide for themselves to which group they wish to belong. In the World Economic Outlook of the IMF emerging markets are bulked together with all the other developing nations in a category “other emerging market or developing economies”. The World Bank might provide the most detailed view, it recognizes four groups based on the GNI per capita: low income, lower middle income, upper middle income and high income. However a classification based on these criteria doesn’t take into account the rate of economic growth, capital flows or any of the political and institutional changes. 20 Brazil, Chile, Colombia, Czech Republic, Hungary, Indonesia, Israel, Mexico, Peru, Philippines, Poland, South Africa, South Korea, Thailand and Turkey 21 Argentina, Bangladesh, Ecuador, Egypt, Hong Kong, India, Malaysia, Morocco, Pakistan, Panama, Russia, Saudi Arabia, Singapore, Uruguay and Venezuela. 22 Namely the MSCI Emerging Markets Index, the FTSE Global Equity Index and the S&P Global Equity Index.

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II. Which emerging markets target?

As has been said the number of emerging markets targeting inflation has been steadily growing over the years. At this point 15 emerging markets target inflation, against 8 industrial inflation targeters. But do these targeting emerging market economies differ in certain aspects from their non-targeting counterparts? Looking at the industrial inflation targeters it seems that most are small23 open economies relative to other industrial countries as can be seen in figure 4. Figure 5, however, shows the same can’t be said for emerging economies, although they are in general a lot more open than industrial countries. Emerging market economies are not specifically small either: Brazil, Mexico and South Korea are all G20 members. Looking at inflation it seems that inflation targeting countries do know higher inflation than other non-inflation targeting emerging economies. Figure 6 shows the average inflation rate five years before the adoptation of inflation targeting against the average inflation in the same period for the non-inflation targeting emerging economies24. It seems that inflation is generally considerably higher on average before inflation targeting was installed. Corbo, Landarretche Moreno and Schmidt-Hebbel (2002) report though that a disinflationary process was generally started shortly after, or even before, inflation targets were being announced. It might be that these emerging targeters have experienced more difficulty with anchoring inflation, and so inflation expectations, in the past, thus leading them to a framework which has a good reputation regarding inflation anchoring. An equal observation cannot be reported though when looking at the growth rates in figure 7.

In conclusion it seems that, in contrast to industrial countries, emerging inflation targeters aren’t only small open economies. On the other hand inflation targeters do tend to perform relatively worse in keeping their inflation low during their pre-targeting periods.

III. Special issues regarding emerging markets econ omies

Mishkin (2004) outlines five fundamental institutional differences for emerging market economies. These are: i) Weak fiscal institutions; ii) weak financial institutions (including government prudential regulation and supervision); iii) low credibility of monetary institutions iv) currency substitution and liability dollarization; and v) vulnerability to sudden stops of capital inflows. These issues will be shortly discussed and linked to the inflation targeting framework. Additional points of view from other authors will be given as well.

i) Weak fiscal institutions The issue of fiscal dominance has already been raised when talking about the possible disadvantages

and preconditions of inflation targeting (supra). Referring to the unpleasant monetarist arithmetic (see Sargeant and Wallace, 1981), it should be clear that an inflation target can’t be achieved when weak fiscal institutions are present. A full commitment to anchoring inflation to low and stable levels is needed of both monetary and fiscal policy makers. Prudent fiscal policy, however, isn’t enforced in any inflation targeting framework. This coordination between fiscal and monetary policy is especially relevant in emerging markets where prices set by governments are more common. Sudden changes in fiscal prudence or controlled prices might lead to unexpected surges of inflation, leading to missed targets and affect the credibility of central banks. Sims (2005) argues that central bankers should consider fiscal changes as a potential source of shocks, reporting it in inflation reports and keeping it in mind when making projections. On the other hand, this might endangers the independence of a central bank.

23 Based on trade as percentage of gross domestic product. 24 Except Argentina, Russia, Uruguay and Venezuela. These countries knew severe episodes of hyperinflation, which artificially inflated the results.

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Closely linked with a country’s fiscal policy is the institutional commitment to instrument independence of central banks. ‘Instrument independence implies that the central bank is prohibited from funding government deficits, has to be allowed to set the monetary policy instruments without interference from the government and the members of the monetary policy board must be insulated from the political process by giving them long-term appointments and protection from arbitrary dismissal.’25

More transparent and responsible fiscal behaviour would not only show a clear political commitment towards price stability, but also enforce monetary actions within an inflation targeting framework. Such behaviour and instrument independence is often lacking in emerging market economies though.

ii) Weak financial institutions Good financial institutions are a must, not only to efficiently allocate funds, but also to give monetary

policy a clear and predictable transmission mechanism through which to operate. Mishra et al. (2010), however, find that traditional monetary channels are weak and unreliable in low income countries, and Bhattacharya et al. (2011) confirm these findings for the Indian economy. Such unclear transmission mechanisms constrain central banker’s policy options and make outcomes unclear, thus making it more difficult to produce accurate inflation forecast. Moreover, because inflation is a product of a variety of variables, unclear transmission mechanisms make it difficult to pinpoint the origins of inflation. The lack of a deep and liquid financial market also limits the feedback on monetary policy, making it more difficult to evaluate effects.

Furthermore if a banking system is weak, as they often are in developing economies, it might be dangerous to maintain targets for a monetary authority, as argued by Mishkin (2004). Battling high inflation by raising interest rates might cause the collapse of the financial system through a perceived higher risk premium. Markets could panic and reverse foreign capital, depreciating the currency and causing periods of high inflation while at the same time affect dollar liabilities of nationals. Additionally, bailing out the banking system could lead to less coordination between fiscal and monetary policies.

Besides benefitting future development, strong financial institutions create a clear environment for central banks to operate. Maintaining the institutional quality of the financial sector, through prudential supervision, is without a doubt, another important role of the central bank, though one often neglected in emerging markets.

iii) Low credibility of monetary institutions The success of inflation targeting hinges on the construction of credibility (supra). This is especially

crucial in emerging markets where central banks suffer from low credibility. Carare and Stone (2006) note that inflation targeters with low credibility are the most likely to provide financing to their governments and have the least developed financial system.

It must be said though that, since the adoptation of inflation targeting generally coincides with institutional reforms, most emerging markets with inflation targets do enjoy higher credibility than their non-inflation targeting counterparts. This credibility however is threatened when targets are persistently missed or when limited know-how produces incorrect forecasts. Here we can see that a central bank isn’t the only one able to influence its credibility negatively, a bad coordination with the fiscal institutions or a limited understanding of the transmission mechanism might lead to unforeseen deviations from the target, putting the central bank’s credibility on the line. Moreover, transparency plays an important role in communicating possible deviations (and its causes) to the public in order to maintain credibility.

25 Mishkin (2004: 12)

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iv) Currency substitution and liability dollarization Local currencies of emerging markets often have to compete with other foreign currencies in the

domestic economy 26 . Besides economic transaction many liabilities are owned as well in foreign currencies, this is because uncertainty regarding domestic exchange rates gives strong incentives to borrow in more secure foreign capital.

Such currency substitution and liability dollarization is problematic for two reasons. First of all it enforces

the effect of exchange rates to the national economies. The exchange rate already plays a very important role in determining the inflation of emerging market economies. Frankel (2009) argues that the openness of emerging markets makes them very vulnerable to fluctuations in international markets and international exchange rates. Their price-taking position on the trade markets and very low degree of self-sustainability creates a rapid pass-through from international to domestic consumer prices. Due to the high degree of dollarization a devaluation of the local currency might affect the position of national borrowers towards dollar creditors. Moreover, it increases the debt burden of domestic firms with debt denominated in foreign currency. Since assets are typically denominated in domestic currency there is a resulting decline in net worth, increasing adverse selection and moral hazard problems through balance sheet deterioration. Finally leading to financial instability and lower economic activity27. Therefore exchange rates are often kept a close eye on by monetary authorities in emerging market economies. This, however, is inconsistent with the inflation targeting framework which puts the inflation target, not the exchange rate, as primary objective. An inflation targeting regime maintaining a double target (such as an inflation target and an additional exchange rate peg) could raise questions when conflicts between targets arise and create a disbelief in the predictability of a bank’s policy decisions28 , besides promoting time-inconsistent and intransparant behaviour. This might cause some reluctance to adopting the framework in countries who are afraid to let their exchange rate float, the so-called “Fear of Floating”29. A number of central banks in emerging market have adopted inflation targeting frameworks that, at least for some time, have coexisted with crawling exchange rate bands though 30 . Amato and Gerlach (2002) argue that maintaining an exchange rate target may be helpful for emerging markets in transition to a full-fledged inflation targeting regime. They also argue that, due to the heavy impact of exchange rates the central bank has to take the inflation rate into account, clarifying its objectives with intense communication.

A second problem is the fact that a high occurrence of foreign currency in the domestic market makes

the transmission mechanism more dubious and unclear. Combined with the openness of emerging markets it might make it more difficult to distinguish external from domestic shocks. The benefits of having a clear transmission mechanism have already been discussed here.

v) Vulnerability to sudden-stops

A final aspect is their vulnerability to sudden-stops. Sudden-stops, as coined by Dornbush, Goldfajn and Valdes (1995), are substantial unexpected reductions of capital inflows. Such episodes have become more and more frequent since capital markets have known further liberalization. Even though capital mobility should benefit economies theoretically, this isn’t the case in emerging markets. Sudden-stops make capital flows pro-cyclical affecting an authority’s capability to act counter-cyclical to these crises.

26 Mainly the US dollar, though the euro is dominant in Eastern Europe. 27 Mishkin (2004: 23) argues that such a mechanism explains the currency crises in Chile (1982), Mexico (1994-1995), East Asia (1997), Ecuador (1999), Turkey (2000-2001) and Argentina (2001-2002). 28 Such as in Hungary in January 2003 (See Jonas and Mishkin, 2003: 45-46) 29 Coined by Calvo and Reinhart (2000: 2) 30 The central banks of Chile, Columbia, Israel and Poland targeted inflation while using a crawling exchange rate band.

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Kose, Prasad and Taylor (2009) argue that a threshold of financial and institutional development should be attained before liberalization becomes purely beneficial for these countries.

When reacting to sudden-stops standard policy action would be to tightening monetary policy, but this doesn’t take into account the weak banking system and potential risks as discussed above. Calvo (2006) argues that during episodes of sudden-stops interest rates become a very weak instrument for monetary policy. He suggests that central banks should, in such cases, momentarily switch to more robust instruments such as exchange rate pegs. Again this could lead to the perception that an inflation targeting central bank maintains two targets, affecting its transparency and credibility, however this could be limited through clear communication.

IV. Summing up why emerging markets are different

Even though an emerging market grouping unites all countries that are undergoing rapid economic growth and free-market reform, these economies are still extremely different from each other. Not only are they situated in all parts of the world, they also experience different institutional and macro-economic problems. The size of their economies range from the overwhelming size of the Chinese economy, to the smaller economies of Panama and Hungary. Some are open to the world (Hong Kong and Singapore) while others prefer to keep to themselves (Brazil). The emerging market group composed here doesn’t consist out of a set of homogenous countries, but offers a wide variety of country specific characteristics. This variety also explains why countries reacted so heterogeneously on the recent financial turmoil. Even though figure 10 might indicate that emerging inflation targeters were struck severely harder than other emerging economies, Llaudes, Salman and Chivakul (2010) find that it has been mostly the exchange rate regimes which suffered the most. Moreover they find that targeting inflation (or having low historical inflation) limits the effect on sovereign spreads, probably because domestic central banks enjoy higher credibility on average.

Further it seems that the only real distinction that can be made between inflation and non-inflation targeters is the fact that inflation targeters have on average experienced much higher levels of inflation during the years prior to their adoptation.

Because of their differences the emerging markets face a whole array of possible problems regarding their monetary policy, problems that can be fundamentally different from those of industrial countries. These problems mainly arise from lower institutional quality, which cause difficulties when trying to adopt a, relatively new, monetary regime, such as inflation targeting. Therefore there is a rationale to slowly fade into the system rather than converting to full-fledge inflation targeting regime in a short time span.

Because the economic environment of emerging economies is so different from that of the industrial ones, it could be argued that they experience completely different inflation dynamics, as Levin, Natalucci and Piger (2004) argue. Therefore a separate approach might be desirable rather than bulking industrial and emerging countries together in the same sample, though such an emerging market sample might still hide great varieties.

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DOES INFLATION TARGETING MATTER IN EMERGING MARKET ECONOMIES?

Many have argued for and against the success of inflation targeting, and a clear cut consensus is yet to be reached. This difficulty to find an agreement stems from three sources which cloud the interpretability of the data . Firstly, there is the fact that since the mid-1980s most economies have been acting in a more stable economic environment. This, so-called Great Moderation, has stabilized growth and global inflation rates, bringing inflation down to lower levels. This evolution can be seen in figure 8 where inflation rates are clearly converging to one another. Hyvonen (2004: 10) determined that the moderation of inflation was a global economic phenomenon, making it more difficult to evaluate the true cause of disinflation: is lower inflation caused by more credible policymakers (the “good policy” hypothesis) or did policy just become easier due to a more stable economic environment (the “good luck” hypothesis)?

The second difficulty regards a selection-bias towards the choice to target inflation. Most inflation targeting countries knew very high levels of inflation during their pre-targeting periods and, generally, adopted the regime as a reaction to these high levels. This implies that not a random group of countries chooses to target inflation, but that this choice is endogenous to pre-targeting levels of inflation. This selection-bias is problematic because, if the assumption of the Great moderation is true, a convergence of global inflation rates would mean a greater reduction of inflation on average in the targeting countries which might artificially inflate the perceived effect of inflation targeting.

Finally it seems that within the literature a lot of different results are reported simply because of the wide variety of samples being used. Some samples include only industrial countries or only developing countries, others bulk industrial and developing countries together. Some include implicit inflation targeters, others only the ones that explicitly adopted the regime. On top of the country sample, many disagree on the dates of when the actual adoptation of the system occurred31, which clearly influences the chosen time samples. This variety in samples doesn’t only make it difficult to compare studies with different methods, but also yields significantly different results for studies with equal methods.

These three problems cause a lot of difficulty and discussion and that’s why they will occasionally be referred to.

I. Stylized facts

Before starting the econometric approach to assess the effects of inflation targeting, a preliminary look at the recent evolution of inflation, inflation volatility, growth and growth volatility could be beneficial. Four different groups are distinguished: inflation targeting advanced economies 32 , non-inflation targeting advanced economies 33 , inflation targeting emerging economies and non-inflation targeting emerging economies. A great obstacle in clearly representing the data was the existence of periods of hyperinflation, primarily in the emerging market economies. Although some studies tend to omit these

31 Stating one specific date in time might not be as easy as it seems. Various countries choose to fade into the new regime for a variety of reasons. For example Chile, who gradually adopted its new framework over a period of more than a decade in order to be able to maintain control over its exchange rate. Even though there is economic rationale for such a gradual approach it doesn’t facilitate defining a clear starting date for the regime. Therefore many authors construct dates by their own judgment. In the remainder of this paper dates will be based on the ones listed in Pétursson (2004) except those of Indonesia and Turkey which come from Little and Romano (2009). For an overview of the dates see table 1. 32 Australia, Canada, Iceland, New Zealand, Norway, Sweden, Switzerland and the United Kingdom 33 Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, Portugal and the United States

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data from their sample (see Gonçalves and Salles, 2006: 315-316), such an approach might mean a loss of information mainly because, as discussed above, the choice to target inflation is related to the level of inflation in the pre-targeting period. In order to maintain the information contained in high inflation levels a choice was made to equalize all periods of hyperinflation34 to 50 per cent.

Figure 8 shows the average inflation rate since the 1980s in the four different groups. The figure clearly shows that emerging economies have had higher average levels of inflation in the past compared to the advanced economies. Looking at the performance of emerging inflation targeters, an average higher rate of inflation can be observed relative to their non-targeting counterparts. Nonetheless, rates in all groups have been converging to each other in a downward trend over the years, the previously mentioned Great Moderation. Looking at the adoptation dates, one might see the start of this convergence around the time inflation targeting regimes where beginning to be implemented. Figure 9, depicting annual GDP growth rates since the 1980s for the respective groups, doesn’t shows any clear distinctions between the groups, however, in recent years non-inflation targeting emerging markets have on average outperformed emerging inflation targeters.

Another more intuitive approach regarding the effects of an inflation targeting regime is through the use of box-plots. Figures 10 to 13 show the box-plots of respectively average inflation, inflation volatility, average annual GDP growth and GDP growth volatility. These are calculated for the four different country groups as defined above and for three sample periods: Ten years before the adaptation of inflation targeting regime, five years before the adoptation and finally the whole inflation targeting period. Needless to say there is no such date for the non-inflation targeting countries, therefore a fixed year was determined, being 1995 for the advanced economies and 1999 for the emerging economies35. Regarding Inflation and its volatility the same downward trended convergence can be seen as mentioned above. The inflation targeting countries clearly showed the largest decline in inflation, especially in the emerging economies, however volatility stayed rather equal five years before and after the inflation targeting regime was announced. Again no clear international evolution can be seen for GDP growth or its volatility. Remarkable however, is the rise in GDP volatility in the advanced inflation targeting nations compared to 5 years prior of the inflation targeting regime. Part of this could be explained by the fact that longer spans of time might compute higher volatility, and on average the post inflation targeting period spans over 15 years in advanced economies (and 10 in emerging).

A typical criteria to judge the success of an inflation targeting regime is to look at its capability to reach the pre-set target. Figure 14 shows the evolution of inflation36 and the target in all of our 15 inflation targeting emerging markets. Clearly some authorities have been more successful in achieving their targets than others. However, it is clear that most countries experienced even higher and even more volatile inflation rates before they started targeting inflation37. The clearest examples of this are Chile, Mexico and Peru, which, after a decade of hyperinflation, managed to bring inflation rates back to moderate levels shortly after the new regime was installed. In order to compare the result of the different countries the sum was taken of all the periods when the target was met, undershot or exceeded (one period equals a trimester). The results can be seen in table 2. The best performing economies missed their target about 34% of the time (Brazil and Thailand) while the worst performer (Indonesia) missed its

34 Which are determined as periods with inflation rates higher than 50%. 35 This date is the average year of when inflation targeting was installed in respectively advanced and emerging economies. 36 The Consumer Price Index (CPI) was used to represent the inflation rate, however this might not be used as the reference rate in a particular regime. 37 The start of the inflation targeting regime is indicated by the black dot, note however that in the case of Indonesia, Mexico and Turkey targets for inflation were already published before authorities fully committed to inflation targeting as a framework.

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target over 90% of the time. It must be said that besides the two best performing economies all other countries missed the target over half of the time. The final column of table 2 shows how many percentage points of inflation a country actually over- or undershot its target since adopting inflation targeting. Here it seems that most economies didn’t perform as badly as the first columns would make us believe. Some countries only deviate slightly (Colombia, Peru, South Korea and Thailand) while others do considerably worse (Chile, Israel and Mexico)38. Even though this isn’t an adequate method of assessing the success of inflation targeting one must admit that achieving the target is an essential problem in emerging inflation targeters. When this becomes a persistent phenomenon the credibility of monetary authorities, one of the central pillars of inflation targeting, one the line.

Roger and Stone (2009) make a critical footnote though. They admit that emerging markets perform significantly worse compared to advanced economies regarding hitting their targets. This, however, can be related to the volatility of inflation in both the groups. Advanced economies often portray stable rates of inflation during their pre-target periods, while emerging markets, in general, come from very unstable periods and, generally, apply inflation targeting to start a disinflationary process. According to Roger and Stone (2009) the missing of targets doesn’t reflect the incapability of central banks, but rather is the result of the difficulty in controlling and predicting inflation in periods of strong disinflation.

Regarding the missing of targets Schaechter et al. (2000) note that it hasn’t yet affected credibility thanks to good communications efforts of the central banks themselves. As previously discussed central bankers can deviate from the target in the short run if economic conditions require it to. When such decisions are well communicated towards the public, central bankers might even gain credibility. They might be perceived as a professional institution making sound economic judgments rather than being button pushers obsessed with meeting targets at any cost. To foster such behaviour most frameworks contain escape clauses to protect monetary authorities from persecution when deviating from the target is rational given the economic conditions39.

In conclusion, a preliminary look at the data suggests that inflation targeting could have a significant role in lowering inflation and its volatility, whether inflation targeting played the primary role cannot be said though due to the presence of the Great Moderation. The so called “conservative window dressing” argument can neither be validated nor be dismissed with this first look. The results regarding growth and its volatility aren’t as apparent, at this point it is hard to make any first conclusions. Finally it seems that emerging market inflation targeters have been moderately effective in reaching their targets, especially when keeping in mind that predicting inflation during a disinflationary process contains much more difficulties than during stable periods.

II. Literary overview

Many have attempted to evaluate inflation targeting since the adaptation of New Zealand. In what follows some of the more recent research will be discussed. In the early years of assessing the effect of inflation targeting a more intuitive approach was used to evaluate the regime. Effects were mainly studied through case-studies and by looking at the evolution of the country’s inflation rate, rather than comparing the inflation results to other non-inflation targeters. The results of these studies were overwhelmingly in favour 38 This doesn’t paint a fair picture though: Chile and Mexico where dealing with hyperinflation when first setting a target for inflation and since disinflation has been reached deviation have been much more limited, while Israel already employs an inflation targeting regime since the early 90s and so had more time to miss targets than a newcomer like Indonesia or Turkey. 39 The Czech central bank for example is allowed to deviate from the target when faced by raw material price shocks agriculture production shocks, natural disasters or exchange rate movements unconnected with domestic economic fundamentals and monetary policy. The South African central bank is exempt of meeting the target when “major unforeseen events outside central bank control” occur.

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of inflation targeting. Later studies with more econometric approaches yielded more moderate results than primarily depicted. Empirical studies have mainly been focused on the industrial targeters, even though emerging market targeters outnumber industrial ones. First some of the research using a country sample consisting solely of industrial countries will be looked at, secondly research including both industrial and emerging or developing countries will be discussed, and finally research focusing on emerging markets will be looked at. Because of the nature of this paper more emphasize will be put on studies regarding emerging economies even though this doesn’t represent the emphasize present in the literature. A small overview of the studies based on their country sample is given in respectively tables A, B and C.

i. Research for industrial economies

Johnson (2002) compared data of five inflation targeters to six non-inflation targeters , all industrial countries, and found a significant reduction in inflation and inflation expectations during the period after the announcement of an inflation targeting framework. Forecasting errors however weren’t significantly different between both groups. He notes that this insignificant results still remains remarkable, for inflation targeting countries generally knew a greater disinflationary process, during which forecasting is considered to be more difficult, so relatively speaking targeters have outperformed their counterparts in forecasting inflation.

Neumann and Von Hagen (2002) studied the inflation rate of six inflation targeters since the late 1970s and compared these to three major non inflation targeters. They find that inflation, and its volatility, has dropped significantly during the sample period and even claim that inflation targeters have closely converged to the stability performance of the Bundesbank. However they do not outperform other central banks, concluding that inflation targeting is by no means superior to other regimes, such as monetary targeting.

Ball and Sheridan (2005) were one of the first to argue against the positive effects of inflation targeting. They argue that because inflation targeters performed worse in keeping inflation down in the pre-targeting regime, the drop in inflation is merely a regression to the mean rather than a real improvement. When correcting for this regression to the mean they find no significant effect of inflation targeting in 7 industrial economies against a control group of 13 other OECD countries. This result makes them conclude that the institutional change inherent to the adoptation of inflation targeting, such as enhanced independence and announcements of targets, doesn’t significantly influence inflation40. Opponents, however, argue that the countries in the control group are mostly implicit inflation targeters themselves.41

Lin and Ye (2007) try to address the self-selection problem through a propensity score method on 22 industrial economies. Through this they can define how probable it is that a certain country would adopt inflation targeting. They combine the propensity scores with the approach of Ball and Sheridan (2005) and don’t find any significant effects of inflation targeting.

ii. Research including both industrial and emerging economies

Corbo, Landarretche Moreno and Schmidt-Hebbel (2002) evaluate the effect of Inflation targeting in a group of industrial and emerging countries against a control group42 for the period 1990-1999. They found that inflation targeters experienced disinflation rather quickly after adopting the new regime, they note though that most targeters had a higher than average level of initial inflation. These countries were also generally successful in reaching their pre-set inflation targets. Sacrifice ratios for inflation targeters have

40 Supporting the “conservative window dressing” argument of Anna Schwartz 41 Wu (2004) finds the same results when testing for 22 OECD countries. 42 Seven industrial targeters, seven emerging targeters and a control group of eleven countries.

15

Overview of inflation targeting research for indust rial countries

Johnson (2002) Neumann and Von Hagen (2002)

Ball and Sheridan (2005) Lin and Ye (2007)

Total number of countries included 11 9 20 22

Total number of inflation targeters included

5 6 7 7

Findings - Reduction of inflation

and inflation expectations,

- inflation fell faster in targeting countries,

- targeters aren’t significantly better at forecasting inflation.

- Inflation and inflation volatility dropped.

- No significant effects of inflation targeting.

- No significant effects of inflation targeting.

Remarks Targeters knew greater

disinflation, and so in comparison were relatively better to non-targeters.

Targeters don’t outperform other central banks.

Effect of inflation targeting is artificially blown up by regression to the mean. They however don’t find a significant negative effect either.

Use of propensity scores to address selection-bias.

Table A

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declined during the targeting period, the same can be said about output volatility. Further they found that central bank ability to forecast inflation accurately has improved significantly and that inflation persistence was reduced.

Pétursson (2004) is one of the first to investigate the effect of inflation targeting on a more substantial group, namely a group of 21 inflation targeters. He finds that average inflation has significantly dropped after the inflation targeting regime was adopted. He notes, however, that in industrial countries a disinflationary process was already started before the adaptation, so here inflation targeting might have primarily played a role in locking the already achieved disinflation. Even after controlling for the Great Moderation of the 1990s the effect of inflation targeting on average inflation stays significantly negative. Further he finds a reduction in both inflation volatility and persistence, a positive but insignificant effect on growth and a reduction of output volatility.

Levin, Natalucci and Piger (2004) found that inflation targeting played a significant role in anchoring inflation expectations and reducing persistence of inflation in industrial countries. The same can’t be said for emerging markets though. Emerging countries have experienced lower inflation but expectations haven’t been anchored. Furthermore even though inflation volatility has been reduced it remains at high levels, regularly over- or undershooting targets.

Vega and Winkelried (2005) use a matching propensity score technique on a very extensive panel of 23 inflation targeters and 86 non-inflation targeters. They report that targeters have lower long-term annual inflation rates and lower long-term inflation volatilities. They find this for both explicit and implicit inflation targeters. Further a reduction in the inflation persistence of developing countries is reported.

Mishkin and Schmidt-Hebbel (2007) apply the same method as Ball and Sheridan (2005) but estimate both an Ordinary Least Squared (OLS) and an Instrument Variable estimation. The paper finds that inflation targeting is generally beneficial to economic stability (lower inflation, lower inflation volatility, lower inflation persistence and lower growth volatility), with the effects being more significant in emerging markets whereas industrial countries are closer to the average evolution seen in their peers.

Whereas previous studies have mainly focused on the domestic effects of inflation targeting, Rose (2007) examined the effect a regime has on the exchange rates in 45 countries of all income levels. He finds that inflation targeters generally experience lower volatility of both the real and nominal exchange rates in contrast to non-inflation targeters, many of which maintain a fixed exchange rate. Lin (2010) extends this study by controlling for the self-selection problem through the same method as Lin and Ye (2007). His results, for 22 industrial and 52 developing countries, yield no significant results. However when looking at separate country groups some surprising results come forward. Exchange rate volatility knows a significant stabilization in developing nations while volatility rises in industrial economies.

iii. Research for emerging economies

“In many ways, the experience of emerging markets offers a richer set of data for assessing the effects of inflation targeting than that of the industrial countries. The time span covered is short […] but the sample of inflation targeters and suitable comparison countries is considerably larger. Moreover, because many emerging market targeters experienced relatively high levels of inflation and macroeconomic volatility before adopting inflation targeting, it should be easier to discern the effects of inflation targeting. In addition, looking at the experience of emerging markets can provide more useful information about how inflation targeting performs during periods of economic turbulence. While the global inflation and financial market environment has generally been benign in recent years, a number of emerging market inflation targeters were under substantial stress during the course of their inflation targeting regimes (examples

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Overview of inflation targeting research for indust rial and emerging countries

Corbo et al. (2002) Pétursson (2004) Levin et al. ( 2004) Vega and Winkelried (2005)

Total number of countries included 35 27 19 109

Total number of inflation targeters included

14 21 16 23

Findings - Targeters have been

successful in reducing inflation and achieving their targets,

- sacrifice ratio are lower in the targeting period,

- output volatility dropped,

- better forecasting ability.

- Inflation, inflation volatility and persistence dropped significantly,

- output growth and its volatility didn’t change significantly.

- Reduction of inflation, inflation expectations and persistence in industrial countries,

- reduction of inflation in emerging markets,

- inflation expectations have not been anchored in emerging markets,

-volatility, although reduced, remains high in emerging markets.

- Reduction of inflation and inflation volatility,

- reduction of inflation persistence in developing economies.

Remarks The Great Moderation

was controlled for. Inflation targeting might have only played a role in locking the already achieved inflation in the industrial countries.

Inflation targeting doesn’t seem to make emerging markets less fragile to international shocks.

The reduction in inflation and its volatility was as well found for implicit targeters. Use of propensity scores to address selection-bias.

Table B

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Continued: Overview of inflation targeting research for industrial and emerging countries

Mishkin and Schmidt-Hebbel (2007) Rose (2007) Lin (2010)

Total number of countries included 34 45 74

Total number of inflation targeters included

21 23 23

Findings - Reduction of inflation,

inflation volatility and persistence,

- reduction in growth volatility.

- Targeters experience lower exchange rate volatility.

- Exchange rate volatility is reduced in targeting emerging markets,

- exchange rate volatility is increased in targeting industrial countries.

Remarks Effects are more

significant in emerging markets whereas industrial countries are closer to the average evolution seen in their peers.

This applies to both the nominal and real exchange rate.

Use of propensity scores to address selection-bias.

Table B (Continued)

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include Brazil and other Latin American countries in the early 2000s, South Africa in late 2002, and Hungary and Poland since 2000).” (Batini and Laxton, 2007: 473)

Many case studies are available regarding the effects of inflation targeting in emerging market economies (see Bogdanski et al., 2000; Schmidt-Hebbel and Werner, 2002; Jonas and Mishkin, 2003; Hakan Kara, 2006; Ito and Hayashi, 2006; Siregar and Goo, 2008). Most of these studies formulate positive conclusions on the effects of inflation targeting, though many make critical side notes regarding the missing of targets or credibility issues.

Fraga et al. (2003) adopted a more econometric approach and created a small open economy model, representing emerging markets. They conclude that in emerging market economies inflation targeting has been, though successful, extremely challenging. They find that emerging economies experience higher levels of inflation, inflation volatility, output volatility, interest rates and exchange rates in comparison to developed countries. This worse performance is suggested to be due to lower credibility, the lack of fiscal discipline, underdeveloped financial markets and a high vulnerability to external shocks. They note that emerging markets are fundamentally different than industrial ones and, therefore, also need to be discussed separately.

In a reaction to the insignificant results of Ball and Sheridan (2005), both IMF (2005) and Gonçalves and Salles (2006) adopted the same approach but used a sample which only consisted out of emerging economies, of which 13 targeted inflation. Their results claim that, for emerging market economies, inflation targeting does have significant effects on reducing inflation, its variability and output variability, there is no evidence that growth has been damped by inflation targeting. Figures of IMF (2005) however are consistently higher than those of Gonçalves and Salles (2006) due to the fact that the latter omits periods of hyperinflation from its sample.

Divino (2009) looks at the effect of inflation targeting on employment in 25 emerging and developing economies, of which 7 are inflation targeters, for the period 1980 to 2005. He found that inflation targeters generally experience an unemployment level of about 5 per cent lower during the post-targeting level relative to the non-targeters. Targeters also managed to close the output gap by a significant 1 per cent relative to non-targeters. No statistically significant effect could be found for employment volatility, output or output volatility.

Lin and Ye (2009) examine inflation targeting in 52 emerging and developing countries, of which 13 are inflation targeters. Just as their previous study (supra; Lin and Ye, 2007) they avoid the selection-bias through the use of a propensity score method. They conclude, in contrast to their 2007 study, that inflation targeting did have a significant effect in emerging and developing markets, leading to an average fall of 3 percentage points in inflation. Besides the positive effect on inflation, they also note that the institutional reforms are substantially more beneficial in these countries relative to the industrial countries.

20

Overview of inflation targeting research for emergi ng economies

Fraga et al. (2003) IMF (2005) Gonçalves and Salles (2006) Divino (2009) Lin and Ye (2009)

Total number of countries included 12 35 36 25 52

Total number of inflation targeters included

12 13 13 7 13

Findings - Reduction of

inflation in targeters,

- emerging targeters don’t perform as good as their industrial counterparts.

- Reduction of inflation and inflation volatility,

- reduction of Output volatility,

- no significant effect on output.

- Reduction of inflation and inflation volatility,

- reduction of Output volatility,

- no significant effect on output.

- Reduction of unemployment,

- reduction of output gap,

- no significant effect on employment volatility.

- Reduction of inflation and inflation volatility,

- institutional reforms are more beneficial in emerging markets.

Remarks Emerging markets

suffer from low credibility, fiscal dominance, underdeveloped financial systems and a high vulnerability to external shocks.

Note that emerging markets have suffered from periods of hyperinflation in the past which might artificially increase results.

Use of propensity scores to address selection-bias. These results are contrary to their earlier work (Lin and Ye, 2007).

Table C

21

A clear cut consensus is yet to be met among authors regarding the effects of inflation targeting in general. However, some general trends can be seen. A first and important one is the fact that even though some studies fail to find significant effects, none have shown significant negative effects on the domestic economy. So no one has argued against inflation targeting, for it might be adopted for reasons besides inflation stability. Secondly it seems that studies focusing on industrial countries generally yield insignificant, or only marginally significant results, while samples containing emerging markets yield significant result. Even though the literature focusing on emerging markets is very limited, a preliminary conclusion might state that inflation targeting has a beneficial effect in emerging market economies. A third finding states that the composition of a sample might significantly influence the results as noted by Mishkin and Schmidt-Hebbel (2007). This doesn’t only apply for the country grouping but also to the perceived date of initial inflation targeting which knows different definitions within the literature. Finally inflation targeting is still a relatively young phenomenon and so the sample time of many studies is rather limited. Data is further clouded by the Great Moderation and the self-selection-bias (supra). In their 2005 highly influential paper, Ball and Sheridan state “Perhaps future policymakers will face 1970s-sized supply shocks, or strong political pressures for inflationary policies. At that point, we may see that inflation targeters handle these challenges better than policymakers who just do it.” (Ball and Sheridan, 2005: 25)

III. Empirical study

In what will follows the effect of inflation targeting on inflation, inflation volatility, inflation persistence, output growth and output growth volatility will be assessed through the use of two different approaches. The first follows the highly popular approach of Ball and Sheridan (2005). By extending a standard difference-in-difference approach this approach managed to avoid the selection-bias. The second approach is based on the methodology applied by Pétursson (2004), which uses panel data to assess the effects of inflation targeting while controlling for the Great Moderation. Here there are several benefits to using two approaches instead of only one. Both approaches control for an individual phenomena which might cloud the data (i.e. the selection-bias and the Great Moderation). Furthermore, not all of the five above mentioned variables can be tested for each approach43. Besides these two each approach has its own merits. This section is concluded with a comparison of the, in this paper, obtained results with those reported in similar studies.

a. The difference-in-difference approach of Ball an d Sheridan (2005)

As said above the difference-in-difference (DiD.) approach of Ball and Sheridan (2005) has been frequently used, and elaborated on, to assess the effects of inflation targeting (see Hyvonen, 2004; Vega and Winkelried, 2005; IMF, 2005; Gonçalves and Salles, 2006; Mishkin Schmidt-Hebbel, 2007; Batini and Laxton, 2007; Divino, 2009), and therefore results can easily be compared to other studies. A difference-in-difference approach examines the effect of a certain treatment (in this case inflation targeting) on a variable through comparing the treatment group after treatment to the treatment group before treatment and a control group (a group not undergoing the treatment). The untreated control group represents what would have happened in the absence of the treatment. Although the approach is simple, intuitive and clear it also has some flaws. First of all both the treatment and control group are supposed to be composed randomly, this of course generally isn’t true in economics44. Further this also is a typical black box approach. Only whether there has been a significant effect, not the source of this effect, can be determined.

43

The Ball and Sheridan (2005) approach will study the effect on inflation, inflation volatility, output growth and output growth

volatility; The Pétursson (2004) approach will study the effect on inflation, inflation persistence and output growth. 44 In this specific case we are dealing with the selection-bias.

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Suppose that we are interested in the effect of inflation targeting on a certain economic variable X (in this paper X will represent the inflation rate, the output growth and their respective volatility) and let Xit be its value in country i at period t. Assume that Xit is given by

(1) ��� = � +��� +µ� +�� +��� ,

where � is a constant, �� a dummy variable equal to unity if country i targets inflation and zero otherwise, µ� and �� respectively capture the country- and period-specific effects, ��� is the error term. Two periods

for t will be used, namely “pre” and “post”, reflecting the period before and after inflation was targeted. Consequently �� �� ��� ���� will equal the average value of X during the pre-targeting (post-targeting)

period. Because of this we are facing country cross-sectional data. For all countries � �� equals zero, for

inflation targeters � ��� equals one. Our objective is to find the effect of inflation targeting on X, in other

words we want to know the estimate value of coefficient �. Differencing equation (1) over time yields

�� ��� −�� �� = � ��� +�� ��� +µ� + �� ��� − �� �� +�� �� +µ� +�� ���

(2) �� ��� −�� �� = �� ��� − � ��� +��� ��� − � ��� + ��� ��� − � ���,

which can be interpreted as an OLS estimator as follows

(3) �� ��� −�� �� = �� +��� + �,

where �� represents the inflation targeting dummy. If � would be negative and significant, it would imply that inflation targeting countries knew a greater reduction of average inflation over the two periods relative to non-inflation targeters.

Equation (3), which had been used by several to evaluate the effects of inflation targeting and typically yields significant results, can be misleading due to the selection-bias discussed above. ‘For some versions of the variable X, the initial value, Xpre, is substantially different on average for inflation targeters and non-targeters. For example, average inflation in the pre-targeting period is higher for targeters. This fact is not surprising: a switch to targeting was most attractive to countries with poor performances under their previous policies. However, a problem arises because of regression to the mean. Poor performers in the pre-targeting period tend to improve more than good performers simply because initial performance depends partly on transitory factors. If inflation targeters are poor initial performers, they will improve more than non-targeters, even if targeting does not affect performance. The coefficient on the targeting dummy can be significant, producing a spurious conclusion that targeting matters.’ (Ball and Sheridan, 2005: 9)

Taking this regression to the mean into account we consequently recognize that in equation (2) � �� is

positively correlated with the dummy due to �� �� determining the decision to target inflation while � �� is

a dependent variable of �� ��. Consequently the OLS estimates for � are biased downwards. In order to

control for this bias we add �� �� as an independent variable, this yields following equation

�� ��� −�� �� = �� ��� − � ��� +��� ��� − � ��� +���� �� +��� ��� − � ���

(4) �� ��� −�� �� = �� +��� + ���� �� + � .

The coefficient on the dummy now shows whether targeting affects a country’s change in performance for a given initial performance. Thus by adding �� �� as a dependent variable we controlled for the fact

that inflation targeters had, on average, higher initial levels of inflation. Thereby we avoid out of proportion estimates due to a bigger drop of inflation in absolute terms. Equation (4) can be estimated through the OLS method and will yield consistent results.

23

i. Data

Inflation is measured as quarterly percentage change in the Consumer Price Index (CPI) from the IMF’s International Financial Statistics (IFS). Growth data is annual percentage change in GDP from de World Bank’s World Development indicators (WDI).

Defining the pre- and post-targeting periods has been based on the adoptation dates (see table 1) listed in Pétursson (2004), except for the dates of the most recent inflation targeters, Indonesia and Turkey, which are from Little and Romano (2009). Representative adoptation date for non-inflation targeting countries is 1999, which is the mean year of when inflation targeting was adopted in emerging market economies. For robustness reasons three different pre-targeting periods have been defined and are represented in table 3. The first starts at the first quarter of 1980 (�����), the second start at the first quarter of 1985 (�����) and the third one begins five years before the adoptation date (�������� ����), all

of them end one quarter before the adoptation date (or 1999 for non-inflation targeting countries). The post-targeting period (�� ���) starts at the adoptation date and ends in the last quarter of 2009.

Dependent variable: change in adjusted mean inflati on between samples

!"#$% − !&'() !"#$% − !&'(* !"#$% − !*+",!#,

Eq. (4) Eq. (4) Eq. (4)

Constant 3.55 *** 3.22 *** 2.58 *** (1.25) (1.15) (0.90)

IT dummy -2.83 * -2.68 ** -2.04 * (1.42) (1.29) (1.01)

Initial mean -0.79 *** -0.77 *** -0.67 *** (0.05) (0.05) (0.04)

R² 0.9052 0.9128 0.8923

Observations 31 31 31 Table D: Estimation coefficients equation (4) for X representing average inflation, episodes of hyperinflation have been reduced to 50%. Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

ii. Inflation

A potential problem when dealing with inflation in emerging market economies is the occurrence of hyperinflation. Such periods are especially common and persistent in historic data of inflation targeters45 because they often adopt the new regime as a reaction to high inflation levels (as could be seen in figure 14). Hyperinflation mainly causes a problem because, when rates drop from artificially high levels, it might blow up the effect of inflation targeting. Gonçalves and Salles (2006) argue that hyperinflation is a very distinct phenomenon from moderate inflation and therefore can be treated differently. Following their line of thought quarterly inflation rates higher than 50% were considered to be hyperinflation and were consequently equalized to 50%46. Again this has been done for the same reasons as discussed for figure

45 Out of the 15 inflation targeters 8 (Brazil, Chile, Indonesia, Israel, Mexico, Peru, Poland, Turkey) experienced a period of hyperinflation since the 1980s, only four (Argentina, Ecuador, Uruguay and Venezuela) out of the 16 non-inflation targeters on the other hand experienced similar levels of inflation. 46 Countries portraying periods of hyperinflation weren’t omitted because it would considerably diminish the amount of observations. Furthermore observations with higher than 50% inflation rates weren’t deleted because such an approach might omit too much significant information.

24

8 (supra, p. 11-12). Table 4 shows the average quarterly inflation for emerging economies during the distinct periods, table 5 shows the same figures but adjusted to hyperinflation. The effect hyperinflation had on the averages was substantial, but the general trend is maintained: inflation in both targeters and non-targeters dropped but relatively more in the former than the latter.

Equation (4) is both estimated for all periods defined above and results are reported in table D. From tables 4 and 5 we already knew that both groups demonstrated a drop in average inflation, the results in table D, in addition, suggest that average inflation dropped significantly more for inflation targeters, even after controlling for mean reversion. Average inflation dropped between 2.04 and 2.83 per cent, depending on which sample period one uses, more for inflation targeters compared to non-targeters.47

Tables 6 and 7 show the evolution of inflation volatility during the different sample periods for all emerging markets. Again a downward trend is noticeable, however, this decrease seems to be halted in the non-inflation targeting countries on average. The estimation results for equations (4) are given in table E. This data has again been adjusted for hyperinflation48. The inflation targeting dummy yields significant negative results.

Dependent variable: change in adjusted inflation vo latility between samples

!"#$% − !&'() !"#$% − !&'(* !"#$% − !*+",!#,

Eq. (4) Eq. (4) Eq. (4)

Constant 2.97 *** 3.40 *** 4.37 *** (0.97) (0.94) (0.97)

IT dummy -2.94 *** -2.77 ** -2.41 ** (1.04) (1.07) (1.17)

Initial mean -0.71 *** -0.75 *** -0.83 *** (0.09) (0.09) (0.12)

R² 0.7545 0.7733 0.6842

Observations 31 31 31 Table E: Estimation coefficients equation (4) for X representing inflation volatility, episodes of hyperinflation have been reduced to 50%. Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

iii. Output growth

Using the same method we now look whether or not inflation targeting had any effect on output growth and its volatility. Tables 8 and 9 show the evolution of average output growth and average output growth volatility over the different periods. Table F shows the coefficients for average output growth. From the data it seems that inflation targeting has caused lower average growth, just as many opponents argued.

Critics don’t only argue that inflation targeting lowers average growth, moreover they argue that it creates less stable growth. Table G however doesn’t support any such claims. The coefficients for the inflation targeting dummy are all negative but not significant. It seems that no significant change can be seen in average output volatility.

47 Clarifying the constant is parameter �� , IT dummy portrays coefficient � and initial mean coefficient �� from equation (3) and (4). 48 However it must be noted that even without the adjustments the regression still yields significant results.

25

Dependent variable: change in mean output growth b etween samples

!"#$% − !&'() !"#$% − !&'(* !"#$% − !*+",!#,

Eq. (4) Eq. (4) Eq. (4)

Constant 3.99 *** 4.03 *** 3.87 *** (0.51) (0.54) (0.57)

IT dummy -1.02 * -1.05 * -1.10 * (0.53) (0.55) (0.54)

Initial mean -0.76 *** -0.79 *** -0.74 *** (0.09) (0.10) (0.11)

R² 0.7054 0.7103 0.6492

Observations 31 31 31 Table F: Estimation coefficients equation (4) for X representing average output growth. Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

Dependent variable: change in output growth volatil ity between samples

!"#$% − !&'() !"#$% − !&'(* !"#$% − !*+",!#,

Eq. (4) Eq. (4) Eq. (4)

Constant 1.72 * 2.33 *** 2.78 *** (0.87) (0.81) (0.61)

IT dummy -0.91 -0.81 -0.75 (0.55) (0.57) (0.58)

Initial mean -0.54 ** -0.68 *** -0.75 *** (0.20) (0.19) (0.15)

R² 0.2724 0.3485 0.4679 Observations 31 31 31

Table G: Estimation coefficients equation (4) for X representing output growth volatility. Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

Concluding the method of Ball and Sheridan we can state that for our group of 31 countries, of which 16 are inflation targeters, it seems that inflation targeting had a significant role in reducing average inflation and its volatility. No considerable evidence has been found to the claim that inflation targeting creates less stable growth, even if a significant effect would exist it is most likely that the effect on volatility would be negative. Average output growth on the other hand seems to have been significantly lower in the inflation targeting regimes.

A comment on the paper of Ball and Sheridan (2005) was written by Mark Gertler. He points out that the decision whether or not to adopt inflation is clearly an endogenous one. Ball and Sheridan argue that countries adopted inflation targeting as a reaction to high inflation, and that the return to moderate level was merely a regression to the mean. Gertler puts another interpretation on the regression to the mean forward, he states inflation targeting itself facilitated the disinflationary process. The causal variable in such a scenario maintains �� ��. “[O]ne can make an analogy with the identified vector autoregression

(VAR) literature. We know from this work that just because nonmonetary shocks account for most of the

26

variation in output, one cannot conclude that monetary policy is not important. It could be that the response of the economy to these nonmonetary shocks is quite sensitive to the endogenous response of monetary policy. Similarly, the endogenous response of inflation targeting to high inflation within [inflation targeting countries] might have shaped the dynamic response of inflation.” (Mark Gertler in Ball and Sheridan, 2005: 278)

b. Panel data estimation of Pétursson (2004)

Another piece of criticism on Ball and Sheridan (2005) is the fact that, through working with period averages rather than the individual observations, the time dimension of the data isn’t used to its full extent and therefore a lot of the dynamics are being lost. Pétursson (2004) uses the time-dimension of the data to its full extent through the use of panel data analysis. Because of certain global trends to which inflation and other variables are subject to (i.e. the Great Moderation) using the dynamics of the data to its full extent might offer different insights.

Whereas Ball and Sheridan (2005) were mostly concerned by the endogeneity of the choice to target inflation, Pétursson (2004) focuses on the great moderation of global inflation since the 1990s. As could be seen in figure 8, both inflation targeting and non-inflation targeting countries experienced lower and more stable inflation during the last two decades. Pétursson (2004) argues that it’s not clear whether this more moderate economic climate is related to inflation targeting, or rather part of a more general economic phenomena. To address this issue a formal statistical analysis is applied to the data. Another difference with Ball and Sheridan (2005) is the fact that, through working with panel data, the amount of observations is a lot bigger than in a cross-section approach. This gives us the opportunity to work with several different country samples.

i. Inflation

Following regression is estimated for our 15 inflation targeting emerging economies

(5) -�� = .�� + /012�� + 30-��4 + 506��4 + 70�-�8 + 70-�48 + 90�� ,

where -�� is the inflation in country i at time t,.�� is the constant, 12�� the inflation targeting dummy, 6�� is output growth of country i at time t and -�8 is the average inflation rate of a group of non-inflation targeting emerging economies. This final variable controls for the general evolution of the inflation level. The lagged inflation is added for the same reason as in the Ball and Sheridan (2005) model, namely to control for the higher initial inflation in inflation targeting countries. The model is estimated as a seemingly unrelated regression (SUR) with fixed country effects for the period 1980:1 – 2009:4. A SUR is a set of equations which might be related, not because they interact, but because their error terms are related. For example an exogenous rise in global food and energy prices affects domestic inflation in all countries, whereas domestic causes of inflation might not have an effect on other countries. A General Least Squares estimator yields the best, linear unbiased (BLU) estimator. The SUR method is used because by doing so the Nickell bias is avoided49. For robustness reasons different country samples are being used. The first country sample includes all the 15 inflation targeting emerging markets50. The second sample includes the 10 countries that have adopted inflation targeting prior to 2001 51 . The third sample includes the 5 countries that had adopted inflation targeting prior to 2001 and had an average inflation level below 25 per cent in the 1980s52. The fourth sample includes the 3 countries that had adopted inflation targeting prior to 2001 and had an average inflation below 15 per cent in the 1980s53. Finally all countries that had adopted

49 Nickell bias is a downward bias on the coefficients in dynamic panel data. Because here the sample of emerging inflation targeters only consists out of 15 countries, we can consider that such a bias would be present. The complete sample of all emerging economies is bigger (31 countries), however, the bias might still be present, though it won’t be bigger than 5-10 per cent. (Beck, 2005: 10) 50 Brazil, Chile, Colombia, Czech Republic, Hungary, Indonesia, Israel, Mexico, Peru, Philippines, Poland, South Africa, South Korea, Thailand and Turkey. 51 Brazil, Chile, Colombia, Czech Republic, Israel, Mexico, Poland, South Africa, South Korea and Thailand. 52 Chile, Colombia, South Africa, South Korea and Thailand. 53 South Africa, South Korea and Thailand.

27

inflation targeting prior to 2001 and had an average inflation above 25 per cent in the 1980s were grouped54.55

An alternative approach is to include the non-inflation targeting emerging markets and approximate the global disinflation trend -�8 with a time trend λ(t) as shown in equation (6). Now the inflation targeting group can be considered as a ‘treatment group’ and the non-inflation targeting countries as a non-treatment group or control group.

(6) -�� = .�� + /012�� + 30-��4 + 30�-��4� + 30:-��4: + 506��4 + 70(;) + 90��

with (;) representing the time-trend. Again this regression is estimated with a SUR approach, the same country samples are defined but now non-inflation targeting countries are added as well56.

The data for inflation and growth was obtained for a quarterly basis from the IMF’s IFS. As said above -��8 is determined as the average of a group of 11 non-inflation targeting emerging market economies57,

this group excludes countries which experienced serious episodes of hyperinflation. Just as in the difference-in-difference approach, and for the same reasons, two different sets have been used, one which included hyperinflation, another which adjusted hyperinflation to equal 50%.

Table H contains the estimations of equation (5) and (6) for every country sample adjusted for hyperinflation, table 10 shows the estimation results without the hyperinflation adjustment. Estimates for the inflation targeting dummy are generally negative, however, rarely significant. Significant results can only be reported in the country sample of countries with average inflation levels below 25 per cent in the 1980s. Further we report that the trend of global economic inflation levels is rarely significant, and is only really felt in countries with below 15 per cent average inflation in the 1980s. Figures between the two tables can differ significantly because of the adjustments made for inflation, significance levels on the other hand don’t.

ii. Inflation persistence

Some authors 58 have found that inflation targeting has a significant effect on reducing inflation persistence. If inflation targeting lowers inflation persistence this would mean that inflation is caused less by historical inflation, and more by the current economic conditions. In such an environment monetary policymakers would be a lot more capable to influence inflation outcomes. It would also mean that credibility of the central bank has increased because inflation expectations are more forward looking.

A univariate AR(2)59 model is estimated to analyse the effect inflation targeting had on the persistence of inflation

(7) -�� = .� + <-��4 + <�-��4� + =(12��-��4) + >(;) + ?�� ,

where -�� again represents the inflation rate of country i at time t, (12��-��4) is the dummy variable multiplied with lagged inflation, >(;) the time trend.. The memory of inflation prior to the targeting period is

54 Brazil, Czech Republic, Israel, Mexico and Poland. 55 For Bangladesh, the Czech Republic and Russia there was no data available for the 1980s. 56 Non-inflation targeting countries with averages inflation levels lower than 25 per cent in the 1980s are China, Egypt, Hong Kong, India, Malaysia, Morocco, Pakistan, Panama, Saudi Arabia, Singapore and Venezuela; with averages lower than 15 per cent are China, Hong Kong, India, Malaysia, Morocco, Pakistan, Panama, Saudi Arabia and Singapore; with averages above 25 per cent are Argentina, Bangladesh, Ecuador, Russia and Uruguay. 57 Bangladesh, China, Ecuador, Egypt, India, Malaysia, Morocco, Pakistan, Panama, Saudi Arabia and Singapore. 58 Such as Pétursson (2004), Levin et al. (2004), Vega and Winkelried (2005) and Mishkin and Schmidt-Hebbel (2007). 59 In order to test for inflation persistence one might estimate following regression

-�� =.� + <-��4 + =(12��-��4) + >(;) + ?�� , however, such a regression might still contain autocorrelation, and therefore more lags need to be included. Through the use the Breusch-Godfrey test it was determined, the appropriate model would contain two lags.

28

Dependent variable: Inflation rate

All emerging market economies with an inflation targeting regime

Adoptation prior to 2001

Adoptation prior to 2001 and average inflation below 25% in the 1980s

Adoptation prior to 2001 and average inflation below 15% in the 1980s

Adoptation prior to 2001 and average inflation above 25% in the 1980s

Eq. (5) Eq. (6) Eq. (5) Eq. (6) Eq. (5) Eq. (6) Eq. (5) Eq. (6) Eq. (5) Eq. (6)

Constant 0.06 0.93 *** 0.55 0.85 *** 0.81 ** 0.41 ** 0.48 0.17 0.76 2.78 *** (0.33) (0.21) (0.35) (0.21) (0.41) (0.21) (0.32) (0.16) (0.63) (0.58)

IT dummy -0.12 -0.10 -0.34 -0.17 -0.57 ** -0.39 ** -0.17 -0.03 -0.35 0.02 (0.22) (0.19) (0.23) (0.20) (0.24) (0.20) (0.21) (0.16) (0.44) (0.37)

@!%4& 0.97 *** 0.96 *** 0.97 *** 0.96 *** 0.92 *** 0.93 *** 0.87 *** 0.91 *** 0.97 *** 0.94 *** (0.01) (0.01) (0.01) (0.01) (0.02) (0.01) (0.02) (0.01) (0.01) (0.01)

+!%4& -0.04 ** -0.05 *** -0.03 -0.05 *** 0.03 0.02 0.03 0.04 *** -0.12 *** -0.16 *** (0.02) (0.01) (0.02) (0.02) (0.03) (0.01) (0.02) (0.01) (0.04) (0.03)

@%A 0.13 0.13 0.17 * 0.22 *** 0.10 (0.08) (0.08) (0.09) (0.07) (0.12)

@%4&A -0.07 -0.14 -0.18 -0.20 *** -0.09 (0.08) (0.08) (0.09) (0.07) (0.12)

Time trend -0.01 ** -0.00 * -0.00 -0.00 -0.02 *** (0.00) (0.00) (0.00) (0.00) (0.01)

Durbin -Watson 1.2142 1.2150 1.3450 1.2590 1.3282 1.3558 1.3131 1.2146 1.3474 1.2162 R² 0.9729 0.9712 0.9758 0.9713 0.9503 0.9535 0.9240 0.9148 0.9784 0.9711 Observations 1633 3342 1058 2767 575 1810 345 1350 483 957

Table H: Estimates for coefficients equations (5) and (6), adjusted for hyperinflation. Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

29

given by < + <�, its memory after the adoptation would be < + <� + =, therefore a significantly negative = suggests a drop in inflation persistence. The data used for inflation is the same as the one used for equation (5) and (6) and contains all inflation and non-inflation targeters

Table I shows the estimates of equation (7). It seems that inflation targeting has had a significant effect on reducing inflation persistence, though this effect is only present in certain groups of countries, namely countries who adopted the regime prior to 2001 and with average inflation levels under 25 and 15 per cent in the 1980s. When looking at the sample including all inflation countries we see that inflation targeting didn’t have any significant effect, while the included time trend did. It seems unlikely that inflation targeting increases inflation persistence though, because all estimation for = are negative.

Dependent Variable: Inflation rate

All emerging market economies with an inflation targeting Regime

Adoptation prior to 2001

Adoptation prior to 2001 and average inflation below 25% in the 1980s

Adoptation prior to 2001 and average inflation below 15% in the 1980s

Adoptation prior to 2001 and average inflation above 25% in the 1980s

Eq. (7) Eq. (7) Eq. (7) Eq. (7) Eq. (7)

Constant 37.12 *** 34.90 *** 1.17 *** 0.60 *** 100.58 ** (11.13) (13.16) (0.27) (0.13) (41.48)

@!%4& 0.93 *** 0.88 *** 1.37 *** 1.32 *** 0.87 *** (0.07) (0.08) (0.05) (0.03) (0.08)

@!%4B -021 *** -0.18 ** -0.47 *** -0.43 *** -0.18 ** (0.07) (0.08) (0.05) (0.03) (0.08)

CD!%@!%4& -1.40 -2.14 * -0.05 ** -0.10 *** -3.31 (1.07) (1.20) (0.02) (0.03) (2.60)

Time trend -0.32 ** -0.29 -0.00 * -0.00 -0.89

(0.16) (0.19) (0.00) (0.00) (0.59)

R² 0.6466 0.6046 0.9480 0.9298 0.5973 Observations 3353 2783 1797 1338 986 Table I: Estimates for coefficients equation (7). Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

iii. Output growth

It has already been noted that growth dropped slightly during the targeting period compared to the 5 years prior (see table 8), whether or not it was inflation targeting which caused this drop will be examined through following equation

(8) 6�� = .�� +/�12�� + 3�6��4 + 5�E��4 + <����4 + 7��6�8 + 7�6�48 + 9���

where 6�� is output growth in inflation targeting country i at time t, 12�� the inflation targeting dummy equal to unity during periods of inflation targeting, E�� is the real effective interest of country i rate in period t, ��� reflects the real exchange rate of country i at period t ( a rise denotes an appreciation) and finally 6�8 is the weighted average growth in the group of non-inflation targeting emerging markets. This final serves as a proxy for the global growth trend.

30

Dependent variable: Growth rate

All emerging market economies with an inflation targeting Regime

Adoptation prior to 2001

Adoptation prior to 2001 and average inflation below 25% in the 1980s

Adoptation prior to 2001 and average inflation below 15% in the 1980s

Adoptation prior to 2001 and average inflation above 25% in the 1980s

Eq. (8) Eq. (9) Eq. (8) Eq. (9) Eq. (8) Eq. (9) Eq. (8) Eq. (9) Eq. (8) Eq. (9)

Constant 3.11 * 7.17 *** 4.97 *** 8.42 *** 6.09 ** 9.16 *** -1.24 8.65 *** 4.94 *** 7.69 *** (1.73) (1.53) (1.66) (1.64) (2.57) (1.99) (3.82) (1.99) (2.33) (2.09)

IT dummy -0.75 0.36 -1.10 ** 0.07 -1.40 * 0.85 0.77 1.67 ** -0.42 -0.59 (0.55) (0.65) (0.52) (0.60) (0.72) (0.82) (1.46) (0.83) (0.76) (0.90)

+!%4& 0.42 *** 0.19 ** 0.29 *** 0.12 0.22 * 0.05 0.32 -0.00 0.35*** 0.26 ** (0.08) (0.07) (0.09) (0.08) (0.12) (0.09) (0.22) (0.11) (0.10) (0.10)

,!%4& -0.03 -0.06 *** -0.05 ** -0.07 *** -0.12 *** -0.13 *** -0.13 -0.00 -0.01 -0.04 ** (0.02) (0.02) (0.02) (0.02) (0.04) (0.05) (0.09) (0.07) (0.03) (0.02)

F!%4& -0.03 *** -0.03 *** -0.04 *** -0.03 *** -0.04 ** -0.02 ** 0.00 -0.02 * -0.04 -0.05 *** (0.01) (0.01) (0.01) (0.01) (0.02) (0.01) (0.03) (0.01) (0.03) (0.02)

+%A 0.48 *** 0.53*** 0.48 ** 0.49 0.59 *** (0.15) (0.15) (0.19) (0.29) (0.19)

+%4&A -0.09 -0.09 -0.07 -0.04 -0.27

(0.16) (0.16) (0.20) (0.28) (0.21) Time trend -0.02 -0.03 -0.07 -0.09 0.05 (0.05) (0.05) (0.06) (0.06) (0.06)

Durbin -Watson 1.8005 1.8309 1.8569 1.8210 1.7055 1.8104 1.5082 1.8383 1.8672 1.8046 R² 0.3816 0.3284 0.4208 0.3324 0.4796 0.3449 0.3800 0.3772 0.3743 0.3128 Observations 191 396 142 347 81 215 29 161 61 132

Table J: Estimates for coefficients equations (8) and (9). Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.

31

Similarly to our approach regarding inflation we define a second model which includes all emerging markets. Just as in (6) the averages 6�8and 6�48 are replaced with a time trend (t)

(9) 6�� = .�� +/�12�� + 3�6��4 + 5�E��4 + <����4 + 7�(;) + 9��� .

Because of many missing values annual data was used to estimate this equation. All data comes from the World Bank’s World Development Indicators database.

Table J presents the regression estimates. Remarkable is the changing sign of the results. Equation (8) generally yields a negative coefficient while equation (9) yields a positive one. Results for the dummy variable are however generally insignificant. The significant coefficients state that inflation targeting had a negative effect in countries with an average inflation rate under 25 per cent in the 1980s and for all countries switching to the regime prior to 2001, while it had a positive effect in the countries with generally low average levels of inflation in the 1980s. The interest rate and exchange rate generally yield insignificant results, as expected.

IV. Summary of results

Using two methods rather than one offered several benefits. First of all the difference-in-difference approach was a clear and simple method which is frequently used in the literature. The panel data approach on the other hand, even though not very common, has the advantage of using the full time dimension of the data. A summary of the results is reported in table K.

Inflation 1 Inflation Volatility 1

Inflation persistence

Growth Growth volatility DiD. Panel DiD. Panel

Results -2.51 -0.48 2 -2.70 -0.453 -1.06 -1.40 and 1.67 4

Not sign. (-)

Table K: Results of the above estimation. In case of more than one significant result over different samples the average was taken of all significant results.

1 Inflation and inflation volatility are for the dataset adjusted for hyperinflation. 2 For emerging market economies that adopted to the regime before 2001 and had an average inflation rate below

25 per cent during the 1980s. 3 For emerging market economies that adopted to the regime before 2001 and had an average inflation rate below

25 and 15 per cent during the 1980s. 4The negative result applies to emerging market economies that adopted to the regime before 2001 and had an

average inflation rate below 25 per cent during the 1980s. The positive result applies to emerging market economies that adopted to the regime before 2001 and had an average inflation rate below 15 per cent during the 1980s.

Results from comparable studies on the effect of inflation targeting can be seen in table H. As can be seen from in the table, the literature on the subject is rather limited. Furthermore not all aspects have been discussed in as much detail.

Author Inflation

Inflation volatility

Inflation persistence Growth

Growth volatility

Vega and Winkelried (2005) 1 -3.24 -2.11 -0.06 - -

IMF (2005) 1 -4.82 -3.64 - - -6.33

Gonçalves and Salles (2006) 1 -2.33 - - - -1.46 Mishkin and Schmidt -Hebbel (2007) 1 -0.81 - - - -

Divino (2009) 1 - - - Not sign. (-)

Not sign. (-)

Lin and Ye (2009) -2.60 -2.50 - - - Table L: Results of other studies with an emerging market sample. 1 Use an equal approach as Ball and Sheridan (2005).

32

The results reported here are generally in line with what has already been found. Just as all previous research a significant negative effect on inflation, its volatility and its persistence was found. The results regarding growth and growth volatility on the other hand are less clear. This difference might be the result of the time sample used in this paper, which uses recent data up to 2009, and therefore includes figures from during the 2007-2009 economic turmoil. The heavy drop of growth in 2008-2009 might have significantly decreased average growth rates, while it increased volatility in the sample. This could explain why growth volatility turned out to be insignificant (which is contrary to IMF, 2005; and Gonçalves and Salles, 2006) and a significant negative effect is reported on growth (whereas Divino, 2009, finds an insignificant effect).

Two remarkable results are reported though in the Pétursson (2004) approach. First of all we only found a significant reflect of inflation targeting on inflation in a certain group of countries, namely countries with moderately low (under 25 per cent) inflation during the 1980s and that had adopted the regime prior to 2001. Similar countries with levels above 25 per cent and under 15 per cent, on the other hand, didn’t report a significant effect. A possible explanation could be found by looking at the institutional quality of these countries. The fact that some countries encountered low average inflation levels in the past (under 15 per cent), might indicate that they had already achieved high quality institutions early on, thus the beneficial effects of inflation targeting on the institutions were only limited. The ones encountering high average levels of inflation (above 25 per cent), on the other hand, might have had relatively worse institutions, making them unable to fully benefit from the advantages inflation targeting offers. If these assumptions are correct, it might be implied that there is a certain Goldilocks level of institutional quality. Meaning that inflation targeting is only beneficial when institutions enjoy sufficient quality to appropriate the benefits of inflation targeting, while at the same time won’t benefit when they already attained a sufficient level of institutional quality. In other words: to really benefit from inflation targeting institutional quality shouldn’t be too low, nor too high. It should be just right. This hypothesis, however, is derived purely intuitive. Research regarding inflation targeting in emerging markets is lacking, therefore research regarding the role of institutions in inflation targeting regimes for emerging markets is very scarce, if not inexistent.

Another remarkable result is the two contradictive significant values for the effect of inflation targeting on growth, one positive and one negative. The negative effect can be explained through the previously discussed theoretical background: Periods of disinflation were initiated by the start of the inflation targeting regime, leading to lower or negative growth. The full positive effects of lower and more stable inflation on growth might not yet have come out fully because of the limited time sample available. However, in table J we saw that inflation had a positive effect on a group of countries with the lowest inflation rates. These countries - namely South Africa, South Korea and Thailand - adopted inflation targeting at (relatively) low inflation levels, and generally after disinflation was achieved and anchored. In other words: these countries had already undergone the cost of disinflation before the inflation targeting regime started.

33

CONCLUSION

A lot has been already said about inflation targeting in recent years and the debate is still raging. Studies on the effects of inflation targeting in industrial economies are easy to find, studies focussing on emerging economies, however, aren’t. This is remarkable not only because the emerging inflation targeters outnumber the industrial ones, but as well because of the growing global importance of emerging economies on global markets. Therefore a good understanding of both the effectiveness and consequences of economic policy in those countries is crucial. This understanding, however, can’t be derived from studies focussed on industrial economies. Emerging economies face substantially different economic conditions and fundamentals than those faced by industrial economies.

This paper took one of the first attempts to look at the effect of inflation targeting for a country sample composed out of emerging market economies. Through the use of two approaches the effect of inflation targeting on inflation, inflation volatility, inflation persistence, output growth and output growth volatility was assessed. The choice to adopt two approaches rather than one has several reasons. First of all, each approach controls for a phenomena which might cloud the data (i.e. the selection-bias and the Great Moderation). Second, the method of Ball and Sheridan (2005) is widely used among authors, and therefore results can easily be compared. Third, the Pétursson (2004) approach used the time dimension of the data to its full extent, thanks to the use of panel data. Moreover, the approach allows us to use different sample groups without reducing the sample size to very low levels. Finally, the two approaches allow us to test the effect of inflation targeting for all five of the above mentioned variables.

The results for (average) inflation, inflation volatility and inflation persistence are all in favour of inflation targeting. The results for the Pétursson (2004) estimates, however, seem to depend on the country sample. Seemingly only countries with moderately high levels of initial inflation seem to have known a reduction in inflation rates due to inflation targeting. Inflation targeting has had no apparent significant effect on inflation persistence in countries with very high levels of initial inflation. This observation has led to the hypothesis that a country’s institutional quality needs to lie between a certain margins to fully benefit from inflation targeting.

The results regarding growth and growth volatility are mixed. First of all no evidence can be found that inflation targeting had a significant effect on growth volatility. Regarding output growth, on the other hand, significant negative results are obtained. It is very likely that this negative effect is caused by the loss in output growth endured during the initial period of strong disinflation. According to many, once this disinflation ends, countries should find themselves in stable economic environments, benefiting growth. Such a presumption is strengthened by the positive result obtained for a sample consisting out of countries with low initial inflation. These countries had already realized disinflation before they started targeting inflation and now report a positive effect of the regime on growth.

At the end it seems that inflation targeting did have an import role in reducing inflation rates in emerging economies, though other factors, such as the more moderate economic climate, must be taken into account as well. The negative effect on growth seems to be only a temporary phenomenon, which hasn’t faded away yet due to the limited time-sample available. More research focussed on inflation targeting in emerging economies needs to be done in order to understand the real effects of the regime in those countries. Such research might prove to be crucial in the further economic and social development of these rapidly changing economies.

34

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38

APPENDIX

Figure 2: Number of countries with an inflation targeting regime installed per year. Based on Walsh (2009: 198)

Source: Date of adaptation of Australia, Brazil, Canada, Chile, Colombia, Czech Republic, Hungary, Iceland, Israel, Korea, Mexico,

New Zealand, Norway, Peru, the Philippines, Poland, South Africa, Sweden, Switzerland, Thailand and the United Kingdom are

based on Pétursson (2004); dates for Finland, Ghana, Indonesia, Romania, Slovakia, Spain and Turkey are based on Little and

Romano (2009).

Figure 2: Percentage of global production per country or country-group.

Source: World Bank World Development Indicators

0

5

10

15

20

25

30

Industrial economies Emerging and developing economies

7%

9%

13%

Total industrial IT Total emerging IT Total emerging non-IT

Rest of the world Japan USA

39

Figure 3: Percentage of global population per country or country-group.

Source: World Bank World Development Indicators

Figure 4: Import and export as percentage of gross domestic product for 8 industrial inflation targeters and 4 non-targeters.

Data for 2007. Based on Ito and Hayashi (2004: 8)

Source: World Bank World Development Indicators.

2%14%

46%

Total industrial IT Total emerging IT Total emerging non-IT

Rest of the world Japan USA

0

20

40

60

80

100

120

Au

stra

lia

Ca

na

da

Ice

lan

d

Ne

w Z

ea

lan

d

No

rwa

y

Sw

ed

en

Sw

itze

rla

nd

Un

ite

d K

ing

do

m

AV

ER

AG

E

Fra

nce

Ge

rma

ny

Jap

an

Un

ite

d S

tate

s

AV

ER

AG

E

Import (% of GDP) Export (% of GDP)

Inflation Targeting Non-Inflation Targeting

40

Figure 5: Import and export as percentage of gross domestic product for 15 emerging inflation targeters and 16 non-targeters.

Data for 2007. Based on Ito and Hayashi (2004: 8)

Source: World Bank World Development Indicators.

Figure 6: Average inflation rate 5 years before adoptation of the inflation targeting regime compared to the average inflation

rate during the same period in non-inflation targeting emerging economies (Except Argentina, Russia, Uruguay and Venezuela)

Source: IMF World Economic Outlook database, Pétursson (2004) and Little and Romano (2009).

0

50

100

150

200

250B

razi

l

Ch

ile

Co

lom

bia

Cze

ch R

ep

ub

lic

Hu

ng

ary

Ind

on

esi

a

Isra

el

Me

xic

o

Pe

ru

Ph

ilip

pin

es

Po

lan

d

So

uth

Afr

ica

So

uth

Ko

rea

Th

ail

an

d

Tu

rke

y

AV

ER

AG

E

Arg

en

tin

a

Ba

ng

lad

esh

Ch

ina

Co

lom

bia

Ecu

ad

or

Eg

yp

t

Ind

ia

Ma

lay

sia

Mo

rocc

o

Pa

kis

tan

Pa

na

ma

Ru

ssia

Sa

ud

i A

rab

ia

Uru

gu

ay

Ve

ne

zue

la

AV

ER

AG

E

Import (% of GDP) Export (% of GDP)

0,00

5,00

10,00

15,00

20,00

25,00

30,00

35,00

40,00

Average inflation during five years before IT

Average inflation in non-inflation targeting emerging economies in the same period

0

50

100

150

200

250

300

350

400

450

Ho

ng

Ko

ng

Sin

ga

po

re

Inflation Targeting Non-Inflation Targeting

41

Figure 7: Average growth rate 5 years before adoptation of the inflation targeting regime compared to the average growth rate

during the same period in non-inflation targeting emerging economies.

Source: IMF World Economic Outlook database, Pétursson (2004) and Little and Romano (2009).

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

8,00

Average growth during five years before IT

Average growth in non-inflation targeting emerging economies in the same period

42

Figure 8: Average Inflation rate in inflation targeting advanced economies, other advanced economies, inflation targeting emerging markets and other emerging markets. Dots

represent the date of adoptation of an inflation targeting framework.

Note: Emerging market grouping is defined as above; List of advanced economies is taken over from Mishkin and Schmidt-Hebbel (2007), Inflation targeting advanced economies

are Australia, Canada, Iceland, New Zealand, Norway, Sweden, Switzerland and the United Kingdom, non-Inflation targeting advanced economies are Austria, Belgium, Denmark,

France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, Portugal and the United States; Inflation rates higher than 50% have been normalized to equal 50%

Source: IMF World Economic Outlook database, Pétursson (2004) and Little and Romano (2009).

0

5

10

15

20

25

30

35

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

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96

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97

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98

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99

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00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

IT: Advanced Economy

non-IT: Advanced Economy

IT: Emerging Economy

non-IT: Emerging Economy

Date Adoptation Advanced

Economy

Date Adoptation Emerging

Economy

43

Figure 9: Average annual GDP growth rate in inflation targeting advanced economies, other advanced economies, inflation targeting emerging markets and other emerging

markets since 1980. Dots represent the date of adoptation of an inflation targeting framework.

Note: Emerging market grouping is defined as above; List of advanced economies is taken over from Mishkin and Schmidt-Hebbel (2007), Inflation targeting advanced economies

are Australia, Canada, Iceland, New Zealand, Norway, Sweden, Switzerland and the United Kingdom, non-Inflation targeting advanced economies are Austria, Belgium, Denmark,

France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, Portugal and the United States.

Source: IMF World Economic Outlook database and Pétursson (2004).

-6

-4

-2

0

2

4

6

8

10

19

80

19

81

19

82

19

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00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

IT: Advanced Economy

non-IT: Advanced Economy

IT: Emerging Economy

non-IT: Emerging Economy

Date Adoptation Advanced

Economy

Date Adoptation Emerging

Economy

44

Figure 10: Box-plot average inflation ten years before, five years before and after the adoptation of an inflation targeting

regime.

Note: For non-inflation targeters 1995 and 1999 represent the date of adaptation for respectively advanced and emerging

economies; Extreme values have been left out for clarity reasons

Source: IMF World Economic Outlook, Pétursson (2004) and Little and Romano (2009)

0

2

4

6

8

10

12

14

10 yearsbefore

5 yearsbefore

After

IT: Advanced Economy

-2

0

2

4

6

8

10

12

10 yearsbefore

5 yearsbefore

After

non-IT: Advanced Economy

0

20

40

60

80

100

120

10 yearsbefore

5 yearsbefore

After

IT: Emerging Economy

-5

0

5

10

15

20

25

30

35

40

45

10 yearsbefore

5 yearsbefore

After

non-IT: Emerging Economy

45

Figure 11: Box-plot inflation volatility ten years before, five years before and after the adoptation of an inflation targeting

regime.

Note: For non-inflation targeters 1995 and 1999 represent the date of adaptation for respectively advanced and emerging

economies; Extreme values have been left out for clarity reasons

Source: IMF World Economic Outlook, Pétursson (2004) and Little and Romano (2009)

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

5

10 yearsbefore

5 yearsbefore

After

IT: Advanced Economy

0

1

2

3

4

5

6

10 yearsbefore

5 yearsbefore

After

non-IT: Advanced Economy

0

5

10

15

20

25

30

10 yearsbefore

5 yearsbefore

After

IT: Emerging Economy

0

5

10

15

20

25

30

35

10 yearsbefore

5 yearsbefore

After

non-IT: Emerging Economy

46

Figure 12: Box-plot GDP annual growth ten years before, five years before and after the adoptation of an inflation targeting

regime.

Note: For non-inflation targeters 1995 and 1999 represent the date of adaptation for respectively advanced and emerging

economies.

Source: IMF World Economic Outlook, Pétursson (2004) and Little and Romano (2009)

0

1

2

3

4

5

6

10 yearsbefore

5 yearsbefore

After

IT: Advanced Economy

0

1

2

3

4

5

6

7

10 yearsbefore

5 yearsbefore

After

non-IT: Advanced Economy

0

1

2

3

4

5

6

7

8

9

10 yearsbefore

5 yearsbefore

After

IT: Emerging Economy

-8

-6

-4

-2

0

2

4

6

8

10

12

10 yearsbefore

5 yearsbefore

After

non-IT: Emerging Economy

47

Figure 13: Box-plot GDP annual growth volatility ten years before, five years before and after the adoptation of an inflation

targeting regime.

Note: For non-inflation targeters 1995 and 1999 represent the date of adaptation for respectively advanced and emerging

economies.

Source: IMF World Economic Outlook, Pétursson (2004) and Little and Romano (2009)

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

10 yearsbefore

5 yearsbefore

After

IT: Advanced Economy

0

1

2

3

4

5

6

10 yearsbefore

5 yearsbefore

After

non-IT: Advanced Economy

0

1

2

3

4

5

6

7

8

10 yearsbefore

5 yearsbefore

After

IT: Emerging Economy

0

1

2

3

4

5

6

7

8

9

10 yearsbefore

5 yearsbefore

After

non-IT: Emerging Market

48

Figure 24: Average historical inflation rates (solid) and inflation targets (dashed) in emerging economies with an inflation

targeting regime. The black dots refer to the beginning of the inflation targeting regime as perceived by Pétursson (2004) or

Little and Romano (2009) for Turkey and Indonesia.

Source Inflation Rates: International Monetary Fund Financial Statistics

Source Inflation Targets: Websites of central banks, inflation reports, Horská (2002), Armas and Grippa (2005), Galindo (2005),

Hakan Kara (2006), Bank of Israel (2007), Chang (2007), Valdés (2007), Arestis et al. (2008), Kim and Kim (2009), Luangraram et

al. (2009) and Central Bank of Philippines (2010).

0

5

10

15

20

25

30

Brazil Target

-5

0

5

10

15

20

25

30

Chile Target

0

5

10

15

20

25

Colombia Target

-2

0

2

4

6

8

10

12

14

Czech Republic Target

49

Figure 14 (Continued)

0

5

10

15

20

25

30

Hungary Target

-5

0

5

10

15

20

Indonesia Target

-5

0

5

10

15

20

25

30

Israel Target

0

5

10

15

20

25

30

35

Mexico Target

50

Figure 14 (Continued)

-2

3

8

13

18

Peru Target

-2

3

8

13

18

Philippines Target

0

2

4

6

8

10

12

14

16

18

20

Poland Target

0

2

4

6

8

10

12

14

16

South Africa Target

51

Figure 14 (Continued)

0

2

4

6

8

10

12

South Korea Target

-4

-2

0

2

4

6

8

10

12

Thailand Target

0

20

40

60

80

100

120

140

Turkey Target

52

Country Start of framework Country Start of framework

Brazil June 1999 * Peru January 2002 *

Chile September 1990 * Philippines January 2002 *

Columbia September 1999 * Poland October 1998 *

Czech Republic January 1998 * South Africa February 2000 *

Hungary January 2001 * South Korea April 1998 *

Indonesia July 2005 ** Thailand May 2000 *

Israel January 1992 * Turkey January 2006 **

Mexico January 1999 *

Table 1: Starting date of inflation targeting framework in emerging market economies.

Source: Pétursson (2004) (*) and Little and Romano (2009) (**)

53

Total

periods

of

Inflation

targeting

periods

under

target

Percent

periods

within

target

Percent

periods

over

target

Percent

periods

with a

missed

target

Percent

Total

inflation

missed

Brazil 47

2 4.3%

31 66.0%

14 29.8%

16 34.0%

52.62

Chile 82

8 9.8%

30 36.6%

44 53.7%

52 63.4%

313.21

Colombia 46

2 4.3%

18 39.1%

26 56.5%

28 60.9%

32.51

Czech

Republic 52

13 25.0%

26 50.0%

13 25.0%

26 50.0%

54.74

Hungary 40

0 0.0%

6 15.0%

34 85.0%

34 85.0%

77.5

Indonesia 40

0 0.0%

10 25.0%

30 75.0%

30 75.0%

104.88

Israel 76

26 34.2%

17 22.4%

33 43.4%

59 77.6%

109.63

Mexico 64

0 0.0%

4 6.3%

60 93.8%

60 93.8%

283.29

Peru 36

10 27.8%

17 47.2%

9 25.0%

19 52.8%

23.84

Philippines 36

14 38.9%

8 22.2%

14 38.9%

28 77.8%

59.59

Poland 52

25 48.1%

11 21.2%

15 28.8%

40 76.9%

58.19

South Africa 44

6 13.6%

18 40.9%

20 45.5%

26 59.1%

63.03

South Korea 51

4 7.8%

25 49.0%

22 43.1%

26 51.0%

26.86

Thailand 44

3 6.8%

29 65.9%

12 27.3%

15 34.1%

27.17

Turkey 36

0 0.0%

5 13.9%

31 86.1%

31 86.1%

179.43

Average 50

8 14.7%

17 34.7%

25 50.5%

33 65.2%

97.77

Table 2: Total periods inflation targets were installed, the amount of periods the inflation target was missed or achieved for emerging markets and the total difference between

the actual inflation and the target.

Note: One period equals to one quarter of a year; The date of adoptation of the inflation target might not coincide with the actual start of the inflation targeting regime.

Source Inflation Rates: International Monetary Fund Financial Statistics; Countries adopting an point target undershot their target if the actual inflation rate is under lower than

50% of the target

Source Inflation Targets: Websites of central banks, inflation reports, Horská (2002), Armas and Grippa (2005), Galindo (2005), Hakan Kara (2006), Bank of Israel (2007), Chang

(2007), Valdés (2007), Arestis et al. (2008), Kim and Kim (2009), Luangraram et al. (2009) and Central Bank of Philippines (2010).

54

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 1980:1 – 1999:1 1985:1 – 1999:1 1994:2 – 1999:1 1999:2 – 2009:4

Chile 1980:1 – 1990:2 1985:1 – 1990:2 1985:2 – 1990:2 1990:3 – 2009:4

Columbia 1980:1 – 1999:2 1985:1 – 1999:2 1994:3 – 1999:2 1999:3 – 2009:4

Czech Republic 1980:1 – 1997:4 1985:1 – 1997:4 1993:1 – 1997:4 1998:1 – 2009:4

Hungary 1980:1 – 2000:4 1985:1 – 2000:4 1996:1 – 2000:4 2001:1 – 2009:4

Indonesia 1980:1 – 2005:2 1985:1 – 2005:2 2000:3 – 2005:2 2005:3 – 2009:4

Israel 1980:1 – 1991:4 1985:1 – 1991:4 1987:1 – 1991:4 1992:1 – 2009:4

Mexico 1980:1 – 1998:4 1985:1 – 1998:4 1994:1 – 1998:4 1999:1 – 2009:4

Peru 1980:1 – 2001:4 1985:1 – 2001:4 1997:1 – 2001:4 2002:1 – 2009:4

Philippines 1980:1 – 2001:4 1985:1 – 2001:4 1997:1 – 2001:4 2002:1 – 2009:4

Poland 1980:1 – 1998:3 1985:1 – 1998:3 1993:4 – 1998:3 1998:4 – 2009:4

South Africa 1980:1 – 1999:4 1985:1 – 1999:4 1995:1 – 1999:4 2000:1 – 2009:4

South Korea 1980:1 – 1998:1 1985:1 – 1998:1 1993:2 – 1998:1 1998:2 – 2009:4

Thailand 1980:1 – 2000:1 1985:1 – 2000:1 1995:2 – 2000:1 2000:2 – 2009:4

Turkey 1980:1 – 2005:4 1985:1 – 2005:4 2001:1 – 2005:4 2006:1 – 2009:4

Non-inflation targeting 1980:1 - 1998:4 1985:1 – 1998:4 1994:1 - 1998:4 1999:1 – 2009:4

Table 3: sample periods for estimates method Ball and Sheridan (2005)

55

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 715,31 879,46 462,15 6,66

Chile 21,59 20,74 20,61 6,94

Columbia 23,18 23,27 19,49 6,05

Czech Republic 9,10 9,10 9,10 3,26

Hungary 15,30 17,84 15,19 5,64

Indonesia 11,40 11,14 8,00 8,41

Israel 112,95 71,23 18,51 5,23

Mexico 46,66 43,20 22,73 6,08

Peru 594,79 745,05 5,02 2,42

Philippines 11,42 8,81 5,79 5,06

Poland 86,71 106,67 27,65 4,42

South Africa 12,26 11,85 7,48 5,97

South Korea 7,43 5,47 5,17 3,16

Thailand 5,40 4,37 5,12 2,53

Turkey 57,43 58,71 29,38 8,92

Average 115,40 134,46 44,09 5,38

Non-inflation targeting

Argentina 618,92 748,73 1,84 8,06

Bangladesh 5,88 5,88 6,20 6,18

China 10,32 10,32 10,31 1,70

Ecuador 35,81 39,59 28,24 19,64

Egypt 14,54 14,08 7,93 7,48

Hong Kong 7,93 7,40 6,57 -0,26

India 9,61 9,28 9,96 6,01

Malaysia 3,71 2,90 3,75 2,20

Morocco 6,31 4,90 3,61 1,72

Pakistan 8,73 8,83 10,55 8,15

Panama 2,18 0,87 1,08 2,40

Russia 256,56 256,56 140,92 19,85

Saudi Arabia 0,76 0,61 1,27 2,08

Singapore 2,50 1,64 1,59 1,47

Uruguay 55,96 60,05 29,40 8,23

Venezuela 36,03 44,23 61,70 22,12

Average 67,23 75,99 20,31 7,31

Table 4: Average inflation rates for different periods of both inflation targeting and non-inflation targeting emerging markets.

Source: International Monetary Fund’s International Financial Statistics.

56

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 41,87 39,59 20,33 6,66

Chile 21,59 20,74 20,61 6,94

Columbia 23,18 23,27 19,49 6,05

Czech Republic 9,10 9,10 9,10 3,26

Hungary 15,30 17,84 15,83 5,64

Indonesia 10,79 10,38 8,00 8,41

Israel 35,62 25,35 18,51 5,23

Mexico 31,95 29,19 22,73 6,08

Peru 34,97 30,56 5,33 2,42

Philippines 11,21 8,81 5,84 5,06

Poland 30,71 33,27 27,65 4,42

South Africa 12,26 11,85 7,48 5,97

South Korea 7,43 5,47 5,17 3,16

Thailand 5,40 4,37 5,12 2,53

Turkey 42,10 42,87 26,95 8,92

Average 22,23 20,84 14,54 5,38

Non-inflation targeting

Argentina 34,01 28,30 1,84 8,06

Bangladesh 5,88 5,88 6,20 6,18

China 10,32 10,32 10,31 1,70

Ecuador 33,15 36,28 28,24 15,23

Egypt 14,54 14,08 7,93 7,48

Hong Kong 7,93 7,40 6,57 -0,26

India 9,61 9,28 9,96 6,01

Malaysia 3,71 2,90 3,75 2,20

Morocco 6,31 4,90 3,61 1,72

Pakistan 8,73 8,83 10,55 8,15

Panama 2,18 0,87 1,08 2,40

Russia 37,92 37,92 35,50 16,36

Saudi Arabia 0,76 0,61 1,27 2,08

Singapore 2,50 1,64 1,59 1,47

Uruguay 41,86 42,64 29,40 8,23

Venezuela 29,84 35,84 45,96 22,12

Average 15,58 15,48 12,74 6,82

Table 5: Average inflation rates for different periods of both inflation targeting and non-inflation targeting emerging markets

with periods of hyperinflation normalized to 50%.

Source: International Monetary Fund’s International Financial Statistics.

57

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 1175,71 1175,71 1283,35 2,98

Chile 8,02 8,02 6,10 6,29

Columbia 4,49 4,49 4,50 2,02

Czech Republic 1,09 1,09 1,09 2,84

Hungary 8,71 8,71 8,40 2,01

Indonesia 12,08 12,08 13,37 4,23

Israel 120,40 120,40 117,49 4,56

Mexico 39,37 41,54 12,87 3,61

Peru 1657,15 1657,15 1858,58 1,76

Philippines 10,79 10,79 6,78 2,57

Poland 201,44 201,44 232,95 3,40

South Africa 3,78 3,78 4,18 3,12

South Korea 6,80 6,80 2,21 1,44

Thailand 4,37 4,37 2,14 2,09

Turkey 27,33 27,33 25,94 1,84

Average 218,77 218,91 238,66 2,98

Non-inflation targeting

Argentina 1946,30 2250,29 1,78 9,19

Bangladesh 2,67 2,67 2,63 2,64

China 8,44 8,44 9,50 2,44

Ecuador 17,79 17,12 5,34 28,17

Egypt 6,36 6,96 4,40 5,09

Hong Kong 2,89 2,78 2,51 2,73

India 2,80 2,82 2,72 3,14

Malaysia 2,22 1,53 0,93 1,58

Morocco 3,62 2,58 1,97 1,27

Pakistan 3,17 3,13 2,54 5,53

Panama 3,25 0,62 0,51 2,39

Russia 305,19 305,19 171,13 23,25

Saudi Arabia 2,44 2,58 1,90 3,32

Singapore 2,60 1,44 1,23 1,90

Uruguay 27,26 28,87 13,32 5,42

Venezuela 26,45 26,13 23,76 7,07

Average 147,72 166,45 15,38 6,57

Table 6: Average inflation volatility for different periods of both inflation targeting and non-inflation targeting emerging

markets.

Source: International Monetary Fund’s International Financial Statistics.

58

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 16,39 17,89 18,46 2,98

Chile 8,02 6,10 6,22 6,29

Columbia 4,49 4,50 2,89 2,02

Czech Republic 1,09 1,09 1,09 2,84

Hungary 8,71 8,40 6,06 2,01

Indonesia 9,13 10,00 3,76 4,23

Israel 15,69 13,00 2,00 4,56

Mexico 15,40 15,79 12,87 3,61

Peru 20,11 20,91 2,93 1,76

Philippines 9,88 6,78 3,40 2,57

Poland 15,02 14,27 9,26 3,40

South Africa 3,78 4,18 2,17 3,12

South Korea 6,80 2,21 1,13 1,44

Thailand 4,37 2,14 2,83 2,09

Turkey 12,08 12,55 15,91 1,84

Average 10,06 9,32 6,06 2,98

Non-inflation targeting

Argentina 21,77 22,79 1,78 9,19

Bangladesh 2,67 2,67 2,63 2,64

China 8,44 8,44 9,50 2,44

Ecuador 12,78 10,93 5,34 17,92

Egypt 6,36 6,96 4,40 5,09

Hong Kong 2,89 2,78 2,51 2,73

India 2,80 2,82 2,72 3,14

Malaysia 2,22 1,53 0,93 1,58

Morocco 3,62 2,58 1,97 1,27

Pakistan 3,17 3,13 2,54 5,53

Panama 3,25 0,62 0,51 2,39

Russia 16,48 16,48 17,06 10,90

Saudi Arabia 2,44 2,58 1,90 3,32

Singapore 2,60 1,44 1,23 1,90

Uruguay 12,58 12,68 13,32 5,42

Venezuela 15,30 13,03 6,12 7,07

Average 7,46 6,97 4,65 5,16

Table 7: Average inflation volatility for different periods of both inflation targeting and non-inflation targeting emerging markets

with periods of hyperinflation normalized to 50%.

Source: International Monetary Fund’s International Financial Statistics.

59

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 2,45 2,82 3,06 3,05

Chile 4,39 7,44 7,44 5,03

Columbia 3,52 3,90 3,42 3,23

Czech Republic -0,09 -0,09 2,31 2,85

Hungary 1,03 0,77 4,19 2,30

Indonesia 5,40 5,07 4,57 5,62

Israel 4,26 4,69 4,92 4,28

Mexico 2,78 2,58 3,01 2,09

Peru 1,77 2,12 2,05 6,01

Philippines 2,53 2,88 3,15 4,74

Poland 3,56 3,56 5,87 4,08

South Africa 1,81 1,43 2,59 3,63

South Korea 7,59 8,14 7,10 3,87

Thailand 6,29 6,53 1,54 4,06

Turkey 4,27 4,45 3,95 1,88

Average 3,44 3,75 3,94 3,78

Non-inflation targeting

Argentina 2,18 2,98 4,10 2,94

Bangladesh 3,96 4,22 4,85 5,73

China 9,99 10,11 10,22 10,04

Ecuador 2,50 2,78 3,00 3,56

Egypt 5,08 4,23 4,63 4,99

Hong Kong 5,66 4,93 2,30 4,72

India 5,57 5,60 6,40 7,11

Malaysia 6,58 6,48 5,80 4,92

Morocco 3,50 3,73 4,29 4,37

Pakistan 5,51 4,87 3,42 4,55

Panama 3,22 3,38 4,24 5,65

Russia -6,16 -6,16 -4,84 5,56

Saudi Arabia 1,35 2,63 1,93 2,99

Singapore 7,56 7,16 6,89 5,73

Uruguay 2,24 4,02 4,20 2,28

Venezuela 1,52 2,72 1,61 2,96

Average 3,77 3,98 3,94 4,88

Table 8: Average output growth for different periods of both inflation targeting and non-inflation targeting emerging markets.

Source: International Monetary Fund’s International Financial Statistics.

60

Pre-period Post-period

Period 1 Period 2 Period 3

Inflation targeting

Brazil 3,87 3,23 1,85 2,09

Chile 6,09 1,67 1,67 3,18

Columbia 1,66 1,64 1,95 2,98

Czech Republic 5,24 5,24 2,47 3,02

Hungary 3,77 4,23 1,74 3,36

Indonesia 4,42 4,67 0,50 0,61

Israel 2,41 2,48 2,88 2,50

Mexico 4,19 3,44 4,68 3,31

Peru 6,39 6,25 2,68 2,70

Philippines 3,71 3,38 2,37 1,70

Poland 4,58 4,58 1,24 1,75

South Africa 2,49 1,96 1,23 2,04

South Korea 2,89 1,99 1,63 4,08

Thailand 4,99 5,73 6,93 2,55

Turkey 4,32 4,54 5,40 4,40

Average 4,07 3,67 2,61 2,68

Non-inflation targeting

Argentina 6,14 6,35 3,73 6,69

Bangladesh 1,25 1,06 0,47 0,66

China 3,19 3,17 1,76 1,90

Ecuador 2,55 2,41 1,16 3,71

Egypt 2,19 1,44 0,57 1,58

Hong Kong 4,38 4,48 4,34 2,78

India 2,96 1,94 1,29 2,09

Malaysia 4,32 5,09 6,65 2,83

Morocco 5,37 5,85 7,37 2,25

Pakistan 2,20 2,03 1,49 1,92

Panama 5,17 5,53 2,22 3,61

Russia 4,68 4,68 4,49 4,51

Saudi Arabia 5,60 4,07 1,26 2,63

Singapore 3,68 4,26 4,35 4,75

Uruguay 5,10 3,11 2,97 6,25

Venezuela 4,44 4,58 3,13 8,21

Average 3,95 3,75 2,95 3,52

Table 9: Average output growth volatility for different periods of both inflation targeting and non-inflation targeting emerging

markets

Source: International Monetary Fund’s International Financial Statistics.

61

Dependent variable: Change in inflation

All emerging market

economies with an

inflation targeting

Regime

Adoptation prior to

2001

Adoptation prior to

2001 and average

inflation below 25% in

the 1980s

Adoptation prior to

2001 and average

inflation below 15% in

the 1980s

Adoptation prior to

2001 and average

inflation above 25% in

the 1980s

Eq. (5) Eq. (6) Eq. (5) Eq. (6) Eq. (5) Eq. (6) Eq. (5) Eq. (6) Eq. (5) Eq. (6)

Constant -2.86 46.25 *** -3.09 39.31 ** 0.81 ** 0.71 ** 0.48 0.17 -11.48 93.31 **

(20.61) (13.53) (18.22) (16.18) (0.41) (0.34) (0.32) (0.16) (42.81) (48.25)

IT dummy 0.99 -17.35 -6.51 -18.61 -0.57 ** -0.46 * -0.17 -0.03 -13.29 -32.47

(15.27) (17.20) (12.51) (12.95) (0.24) (0.25) (0.21) (0.16) (28.12) (39.17)

@!%4& 0.83 *** 0.76 *** 0.87 *** 0.74 *** 0.92 *** 0.92 *** 0.87 * * 0.91 *** 0.87 0.73 ***

(0.04) (0.04) (0.05) (0.05) (0.02) (0.02) (0.02) (0.01) (0.05) (0.05)

+!%4& -5.17 ** -5.10 *** 0.54 -3.31 ** 0.03 0.00 0.03 0.04 *** 2.04 -8.10 *

(2.30) (1.68) (1.49) (1.84) (0.03) (0.02) (0.02) (0.01) (3.73) (4.92)

@%A 0.80 -7.30 0.17 * 0.22 *** -16.39

(5.90) (4.96) (0.09) (0.07) (11.20)

@%4&A 3.95 8.89 * -0.18 ** -0.20 *** 20.29

(5.79) (4.89) (0.09) (0.07) (11.08)

Time trend -0.14 -0.15 -0.00 -0.00 -0.41

(0.19) (0.21 (0.00) (0.00) (0.81)

Durbin-Watson 1.4112 1.6911 1.0388 1.7480 1.3282 1.1201 1.3131 1.2146 1.0414 1.7459

R² 0.7336 0.6319 0.7969 0.5915 0.9503 0.9328 0.9240 0.9148 0.7923 0.5850

Observations 1633 3342 1058 2767 575 1810 345 1350 483 957

Table 20: Estimates for coefficients equation (5) and (6) without adjusting for hyperinflation.

Note: * 10% significance ** 5% and *** 1%, standard errors within parenthesis.