Abstract
A growing number of countries have anchored their monetary policy to an explicit numerical rate or range of inflation since such an inflation targeting framework was first adopted by New Zealand in 1989. This paper empirically investigates economic structure and institutional factors associated with a country’s choice of inflation targeting using a dataset of 66 countries for the period of 1980–2000. It is found that a sound fiscal position is significantly and positively associated with the choice of inflation targeting framework; the central bank is more likely to adopt inflation targeting with greater financial depth; institutional capacity including central bank autonomy and flexible exchange rate regime is important for the choice of inflation targeting.
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Notes
The number of inflation targeting countries might vary depending on the definition of inflation targeting. This issue is further discussed in Section 2.
The selection of the 66 sample countries is based on the list of the 178 IMF member countries, which have data available for most variables between the year of 1980–2000.
Spain actually operated under a de facto mixed regime from January 1995 to December 1998. Spain adopted inflation targeting in January 1995 in the context of an increase in VAT and a concern about the pass-through to inflation. That pass-through was much less than expected, nevertheless the peseta came under downward pressure in March 1995 and was devalued within the widened bands of the exchange rate mechanism of the European Monetary System. In the same formal sense, Finland operated under a de facto mixed regime from January 1995 onward, but it did not experience any conflict situation.
Flows of portfolio investment debt securities and other investment liabilities are accumulated for these four countries since the year when their data are first available. Specifically, 1976 is the initial year for Greece, 1974 for Ireland, 1976 for Singapore, and 1971 for Saudi Arabia.
Willamson and Mahar (1998) suggest that financial depth, measured by M2/GDP, is a helpful indicator to determine a financial system’s efficiency in mobilizing funds to foster economic growth.
Note that the variable for central bank “autonomy” is used, not a variable for central bank “independence,” either instrument or goal independence. See the debate on the role of these two variables in the choice of a monetary framework in Mishkin and Schmidt-Hebbel (2001).
There are a large number of indicators to measure central bank autonomy or independence. However, the reliability and usefulness of these indicators have been questioned, since the existing indicators differ substantially from each other, in terms of the criteria contained in the index, the interpretation and evaluation to these criteria, and the way in which the criteria are aggregated. Thus the choice of indicators could lead to very different results. (Berger et al. 2001; Posen 1998; and Cukierman 1992). However, it does not mean these indicators are uninformative; it implies that the application of indicators is needed to be supplemented by judgment. Cukierman (1992) argues that some indices are more proper for some purpose than for others. For example, the turnover rate for governors or members of the policy board is a good indicator for central bank autonomy.
This paper focuses on the effects of central bank autonomy on the choice of inflation targeting rather than whether the degree of autonomy causes differences in the results. Accordingly, the value 1 is assigned to the dummy for central bank autonomy if the central bank is in full autonomy, and 0 otherwise.
For countries without previously codified central bank autonomy data, Truman used these sources such as mandates to make a judgment, applying his intuition and expertise.
Applying the similar reason used for the variable for central bank autonomy, the value 1 is assigned to the dummy for floating exchange rate regime if it is free or managed floating, and 0 otherwise.
See Reinhart and Rogoff (2002) for a similar discussion.
See a similar argument in Amato and Gerlach (2002).
The level of inflation could affect a country’s choice of inflation targeting; on the other hand, however, the adoption of inflation targeting regime could also affect its inflation rate. See, for example, Neumann and von Hagen (2002) and Wu (2004), for detailed analysis on the impact of inflation targeting regime on inflation rate. Thus we used the one-year lagged inflation rate as the control variable.
See, for example, Huber (1964) for the reference.
To save space, we do not report the estimated coefficients of year dummies.
This result is consistent with the finding by Mishkin and Schmidt-Hebbel (2001) based on a much smaller sample of countries.
According to Truman’s (2003) classification, maintainers’ inflation rates are less than 5% but above zero, convergers’ inflation rates are more than 5% but less than 10%, and squeezers’ inflation rates are 10% or higher.
As analyzed in Chapter 4 in Truman (2003), adopting inflation targeting by G3 (the US, Euro-Area and Japan) would be a “net plus for the world economy”. “G3 should adopt inflation targeting, preferably collectively, or, as a second best, individually to improve their economic performance and to reduce the risk of deflation. The IMF should actively encourage the G3 to do so because of the benefits to the performance of the global economy and the international financial system.” (pp. 215, Truman 2003).
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Acknowledgements
I am grateful to Edwin Truman for his valuable suggestions, and to Matthew Canzoneri, Carol Rogers, Monty Graham, Adam Posen, Stefan Gerlach, Petra Gerlach and other seminar participants and colleagues at the Institute for International Economics, Hong Kong Monetary Authority and University of Hong Kong for their helpful comments. The financial support from the Hong Kong Research Grant Council (AOE/H-05/99) is gratefully acknowledged. All remaining errors are mine.
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Appendix
Appendix
1.1 List of sample countries (66 countries)
Inflation targeters (22 countries) | Non-inflation targeters (44 countries) |
|---|---|
Australia | Argentina |
Brazil | Austria |
Canada | Bangladesh |
Chile | Belgium |
Colombia | Bolivia |
Czech Republic | Bulgaria |
Finland | China |
Hungary | Costa Rica |
Iceland | Denmark |
Israel | Dominican Republic |
Korea | Ecuador |
Mexico | Egypt |
New Zealand | France |
Norway | Germany |
Peru | Greece |
Philippines | Guatemala |
Poland | Honduras |
South Africa | India |
Spain | Indonesia |
Sweden | Ireland |
Thailand | Italy |
United Kingdom | Japan |
Malaysia | |
Morocco | |
Netherlands | |
Nigeria | |
Pakistan | |
Panama | |
Paraguay | |
Portugal | |
Romania | |
Russia | |
Saudi Arabia | |
Singapore | |
Slovak Republic | |
Slovenia | |
Sri Lanka | |
Switzerland | |
Turkey | |
Ukraine | |
United States | |
Uruguay | |
Venezuela | |
Vietnam |