Does Inflation Targeting Really Promote Economic Growth?

ABSTRACT

Inflation targeting, as a monetary-policy framework, is said to promote economic growth. Yet, when evaluating the macroeconomic performance of inflation-targeting regime, the existing literature only emphasizes the dynamics of inflation and the costs associated with taming inflation. There is hardly any assessment of the growth claim. To fill the gap and to measure the causal impact of inflation-targeting adoption on economic growth, we compare the dynamics of output growth and long-term unemployment between countries that have adopted inflation targeting and the non-adopting countries. Our findings seem to refute the growth claim, and paint a bleak picture of inflation targeting: when compared to the countries that did not adopt inflation targeting, there is a significant reduction in the average growth rate among the inflation-targeting adopters by over ½ percentage point. Additionally, long-term unemployment significantly rises among the inflation-targeting countries by over 1½ percentage points as compared to the non-adopters. These results are robust to both the exclusion of the outlier observations and to the sensitivity tests recommended for such analysis.

KEYWORDS:

• Monetary policy
• inflation targeting
• growth
• unemployment

JEL CLASSIFICATION:

• E20
• E24
• E52
• E58

Acknowledgments

First, I want to thank the editor for the patience and care he showed throughout the review process! Second, I want to thank all the reviewers for their valuable comments and suggestions: I learned a lot from your feedback, which has only enhanced the quality of my work. I genuinely admire your altruistic service that you provide to the academia. Thank you so much! Finally, I want to thank my mentors, Marc Lavoie and Mario Seccareccia: merci beaucoup.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 For a complete list of these 30 countries, refer to Table 1 in Section Five.

2 Bernanke et al. (1999) call inflation targeting a ‘constrained discretion’.

3 See Bernanke et al. (1999).

4 See Ball and Sheridan (2003).

5 See, for example, Svensson (1997), who uses the term ‘inflation-forecast targeting’ because, in his view, policy-makers do not have control over inflation; instead they try to influence the inflation expectations of agents.

6 A general solution to this type of model is basically the variance that can be traded-off among the inflation and the output gap, depending on the policy-maker’s preferences; see Orphanides and Williams (2004, p. 206).

7 For more on the link between the Wicksellian theory and the modern central banking, see Seccareccia (1998).

8 For more on Hayek’s view on central banking, see Ferris and Galbraith (2006).

9 In a statement before the Joint Economic Committee of the U.S. Congress on October 17, 1979.

10 Barro (1996) actually mentions 10 per cent increase in the inflation rate causing a reduction of 4–7 per cent in the real GDP.

11 To check whether our empirical findings are robust to this heterogeneity, we subject our sample to the sensitivity test proposed by Rosenbaum (2002), and the results are presented in Table 5.

12 Given that the US joined the IT-club very late, in 2012, we perform the regressions by excluding the US from our data sample, however, there was no noticeable change in the results. We, therefore, keep the US in the data sample.

13 See for example, De Mendonca and De Guimarães e Souza (2012).

14 See Bassanini and Duval (2006) and Dogan (2012) for a rich survey of the determinants of unemployment for advanced as well as developing and emerging countries.

15 Rosenbaum and Rubin (1983) call treatment assignment ‘strongly ignorable’ if these assumptions are satisfied.

16 Barro (1996) uses the GDP deflator in his sample when there are no data on CPI.