Hitting the Target: An Analysis of Inflation Targeting Policies

Abstract: Acknowledging that world inflation reached its highest levels in decades in 2022, this paper investigates how the adoption of an inflation targeting regime has affected the inflation level and the inflation variability for a sample of five advanced economies from 1980 until the end of 2020. This paper discusses the implications of inflation targets in relation to the relative output growth across inflation targeting and non-inflation targeting economies to further contribute to the debate about its efficacy. The study is conducted using the Generalized Synthetic Control Method. With this approach, we allow for a relaxation of the parallel trends assumption, account for multiple treated units, and construct a synthetic control group to mitigate the self-selection bias. The findings provide no statistically significant effects of inflation targets on the inflation rate or inflation variability. A shortcoming of the estimation is that the model failed to construct a sufficient synthetic control, which poses concerns of bias in the estimated treatment effects. The findings related to output growth suggest that inflation targets may hamper the flexibility of central banks, and that the instrument rule may be too vague to be an operational guideline for monetary policy. We argue that whilst inflation targeting may be useful to anchor expectations, its capacity to influence macroeconomic outcomes is subject to the intricate nature of the transmission mechanism, making its impact uncertain.