The effects of inflation targeting on Okun’s law

ABSTRACT

This article provides the first empirical evidence that the adoption of inflation targeting (IT) matters for the extent of tradeoff between unemployment and output, that is Okun’s law. Our full sample results indicate that IT leads to a more negative Okun’s coefficient, suggesting that, for a given reduction of output, the introduction of IT is associated with a higher unemployment rate. Subsample analyses reveal that the whole sample results are mainly driven by the industrial subsample outcomes, not the developing counterparts. Our findings point out that IT not only influences macroeconomic variables per se but also affects the relationship between/among macroeconomic variables.

KEYWORDS:

• Inflation targeting
• Okun’s law
• time-varying
• propensity score matching

JEL CLASSIFICATION:

• E24
• E32
• E40
• E50

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Please see Perman, Stephan, and Tavera (2015) for a recent survey on Okun’s law.

² A brief review of the estimation strategy is provided in Appendix 1.

³ Whenever possible, the subscripts for country i and year t are omitted for brevity.

⁴ Particularly, the medium radius is equal to the standard deviation of the estimated propensity scores, and the wide (tight) radius is selected to be twice (half) the standard deviation.

⁵ As pointed out by a referee, the whole idea is based on the assumption that the Okun’s coefficient in Equation (1) is time-dependent. To check whether the assumption is appropriate, we regress the Okun’s estimates (β) on a time variable (t): The result indicates that the Okun’s coefficients are time-dependent, and decreases over time (on average).

⁶ This is the (STV2) case. The case (STV1) can be defined in a similar way.

Additional information

Funding

The financial support for this study was provided by the Ministry of Science and Technology (Taiwan, Republic of China) [grant number MOST 103-2410-H-032-002-MY2].