Does Inflation Targeting Matter?

The authors find no evidence that inflation targeting on average improves performance as measured by the behavior of inflation, output, or interest rates.

Economists have long sought the ideal framework for monetary policy. Recently, many economists have come to believe that inflation targeting represents that ideal. They cite its many benefits, including solving the dynamic consistency problem that results in high average inflation; reducing inflation variability; stabilizing output; and locking in expectations of low inflation.

In Does Inflation Targeting Matter? (NBER Working Paper No. 9577), authors Laurence Ball and Niamh Sheridan examine twenty OECD countries, seven that adopted inflation targeting during the 1990s and thirteen that did not. The study period lasted through 2001 for most of the countries - for others, the study period lasted only through 1998 because of the advent of the Euro. While economic performance varied widely across individual countries, the authors find no evidence that inflation targeting on average improves performance as measured by the behavior of inflation, output, or interest rates.

Looking at inflation targeting countries alone, the authors find that their performance improved between the period before targeting and the targeting period. For some, inflation fell and became more stable, and output growth also stabilized. However, countries that did not adopt inflation targeting also experienced improvements around the same time period.

For some measures, inflation targeters had greater gains than the other countries. As an example, average inflation fell for both groups between the pre-targeting and targeting periods, but the average inflation for targeters went from above the level of non-targeters to roughly the same level. The authors find that this is likely because of "generic regression to the mean": just as short people, on average, have children who are taller than they are, countries with unusually high and unstable inflation tend to see these problems diminish, regardless of whether they adopt inflation targeting. Once the authors control for this effect, the apparent benefits of targeting disappeared. Nothing in their data suggests that even covert targeters -- and some economists believe the United States is one of these -- would benefit from adopting explicit targets.

The authors point out that their results do not provide an argument against inflation targeting, since they do not find that it does any harm. Indeed, there may be benefits -- possibly political, for example -- to inflation targeting that they do not measure. Targeting also may produce more open policymaking, aligning the role of the central bank with the principles of a democratic society. The authors also suggest that inflation targeting might improve economic performance in the future, since central banks during the study period were not tested severely.

-- Les Picker