Inflation targeting makes the difference: Novel evidence on inflation stabilization

Though Svensson (1997, 2003) provides theoretical evidence that the introduction of inflation targeting is consistent with an inflation stabilizing monetary policy, empirical evidence that the introduction of inflation targeting actually changes central bank’s behavior is still missing. This paper aims to close this gap and estimates forward-looking monetary policy rules for 20 inflation targeting countries. To this end, we use a data set which is available to the central bank in real-time, published on a frequently basis, comparable among all countries, and which includes the periods before and after the introduction of inflation targeting. We find that the introduction of inflation targeting significantly shifts the central bank’s reaction function toward inflation stabilizing. We also provide evidence of time-varying effects and find that central banks stabilize inflation once inflation targeting is introduced. We take our results as strong evidence that the introduction of inflation targeting makes the difference for monetary policy strategies.