Determining factors of the performance of inflation targeting in emerging markets: an empirical assessment

Abstract

Since 1990, 27 countries have adopted a monetary policy called inflation targeting. This policy is more and more being adopted as one of the principal methods of conducing monetary policy. This framework is particularly popular with emerging market economies as it successfully contributed to lower and maintain a steady rate of inflation. Recent studies show the positive impacts of inflation targeting on macro-economic variables. However, some countries are more successful in reaching their inflation target than others. This paper assesses empirical factors determining the ability of central banks to achieve their inflation target, measured by the gap between inflation target and actual inflation. What are the determining factors of the performance of such policy, in particular emerging market economies? Previous literature has shown that institutional characteristics were the main determining factors of the performance of inflation targeting. I extend the search for the main determining factors of the success of inflation targeting. I find two additional layers of determining factors. Country-specific risk factors, such as country risk premium are a second layer of significant determinant of the success of inflation targeting. Then, factors specific to emerging market economies are a third layer of determining factors. I extend the research for a new period of time 2011-2015, and broaden the perspectives by testing for new factors such as political risk factor, and by exploring specificities for emerging market economies. In this research, I examine various factors determining the inflation gap in three layers: institutional characteristics, country-specific risk factors, and factors specific to emerging markets. Empirical results from 2011 to 2015 suggest that factors related to institutional strength (fiscal discipline, central bank transparency, economic growth) and country-risk premium are most significant factors of the effectiveness of inflation targeting. Although this study does not reveal relevant additional factor specific to emerging markets, it shows that inflation gaps in emerging market economies are more sensitive to economic growth and country risk-premium than inflation gaps in developed economies.