Macroeconomic Effects of Inflation Targeting: A Survey of the Empirical Literature

This paper surveys the voluminous empirical literature of inflation targeting (IT). Specifically, the paper focuses on three main issues: the main institutional, macroeconomic, and technical determinants that affect the adoption of IT; the effects of IT on macroeconomic performance (inflation expectations, inflation persistence, average inflation rate, inflation variability, output growth, output volatility, interest rates, exchange rates, and fiscal outcomes); and disinflation costs of IT (the so-called sacrifice ratios). The main findings from our review are the following: concerning the determinants behind the adoption of IT, there is robust empirical evidence that larger and more developed countries are more likely to adopt the IT regime; similarly, the introduction of this regime is conditional on previous disinflation, greater exchange rate flexibility, central bank independence, and higher level of financial development; however, the literature suggests that the link between various macroeconomic and institutional determinants and the likelihood of adopting IT may be rather weak, i.e., they are not to be viewed either as strict necessary or sufficient conditions; the empirical evidence has failed to provide convincing evidence that IT itself may serve as an effective tool for stabilizing inflation expectations and for reducing inflation persistence; the empirical research focused on advanced economies has failed to provide convincing evidence on the beneficial effects of IT on inflation performance, concluding that inflation targeters only converged towards the monetary policy of non-targeters, while there is some evidence that the gains from the IT regime may have been more prevalent in the emerging market economies (EMEs); there is not convincing evidence that IT is associated with either higher output growth or lower output variability; the empirical research suggests that IT may have differential effects on exchange-rate volatility in advanced economies versus EMEs; although the empirical evidence on the impact of IT on fiscal policy is quite limited, it supports the idea that IT indeed improves fiscal discipline; the empirical support to the proposition that IT is associated with lower disinflation costs seems to be rather weak. Therefore, the accumulated empirical literature implies that IT does not produce superior macroeconomic benefits in comparison with the alternative monetary strategies or, at most, they are quite modest.