By how much and why do inflation targeters miss their targets
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¿By How Much and Why Do Inflation Targeters Miss Their Targets?. Elías Albagli Klaus Schmidt-Hebbel Central Bank of Chile Atlanta Fed Conference on “Implementing Monetary Policy in the Americas: The Role of Inflation Targeting Atlanta, 4 October 2004. Inflation convergence under IT.

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By how much and why do inflation targeters miss their targets

¿By How Much and Why Do Inflation Targeters Miss Their Targets?

Elías Albagli

Klaus Schmidt-Hebbel

Central Bank of Chile

Atlanta Fed Conference on “Implementing Monetary Policy in the Americas: The Role of Inflation Targeting

Atlanta, 4 October 2004





This paper s objectives
This paper’s objectives: Targets?

1. Measuring IT performance and accuracy in all inflation-targeting countries, using consistent and robust measures and high-frequency data

2. Explaining IT performance: the role of policy credibility / investment credit risk in determining IT accuracy, controlling for relevant inflation shocks.



  • Data and methodology Targets?

    • Monthly inflation data (yoy), for 19 ITers, 1990-2003

    • Which target? Target point or center point of target range

    • For robustness we use 3 target definitions: Official (OFT), interpolated (IPT), Hodrick-Prescott filter (HPT).










  • Which role do institutional perception / credibility play in IT accuracy?

  • Basic hypothesis: accuracy is higher in countries with more mature institutions and lower risk that support stronger policy credibility and closer alignment of inflation expectations with inflation targets

  • Old idea ... backed by little empirical evidence to date.


  • Previous findings: IT accuracy?

    • Calderón and Schmidt-Hebbel (2003) use Central Bank independence dummy (CBI) and government bond spreads to measure credibility.

    • Both measures of credibility / institutional perception raise IT accuracy.

    • Problems with CBI: displays little time variation, hence hard to exploit time-series data. Makes little difference between ranges of independence (0 or 1).

    • Problems with government bond spreads: Available for few countries, too recent.


  • This paper extends previous evidence in several dimensions: IT accuracy?

    • Higher frequency, more recent data

    • Larger country sample

    • Panel data regressions, IV estimation

    • Tests for alternative measure of credibility / institutional perception: Institutional Investor’s Country Credit Rating (IICR).


  • Institutional Investor’s Country Credit Rating IT accuracy?

    • Measures “investment climate” at country level. Based on evaluation of institutions, corruption, macro policies and performance indicators. Ranges from 0 to 100.

    • Contains information on institutional perception and law enforcement

    • Series available before the 1990s, for all countries in the sample

    • Problem: possible endogeneity  IV estimation.


  • Data and methodology: IT accuracy?

    • Quarterly data, 1990-2003, 19 ITers.

    • Cross-section country averages and panel data (OLS, fixed effects, TSLS).

    • Dependent variable: inflation deviation from target (absolute value).

    • Explanatory variables:

      • Control variables: oil price, US GDP, exchange rates (annual changes and trend deviations, absolute value).

      • Credibility / Institutional Perception: Central Bank independence (CBI), sovereign spreads (SPREADS), and “Institutional Investor’s credit rating” (RISK).


MAD: Mean absolute deviation

TARGET: target average

RANGE: Average target range

DNER: Nominal exchange rate depreciation standard deviation

IICR: Institutional Investor’s Credit Rating average

CBI: Central Bank independence Dummy


AD: Absolute value of inflation deviation

OILG: Oil price GAP (HP filter).

NER: Nominal exchange rate depreciation (YoY)

IICR: Institutional Investor’s Credit Rating

  • TSLS instruments: Exogenous variables (lagged), and RISK(-1).....RISK(-j).



Conclusions
Conclusions IT accuracy?

  • Large deviations from inflation targets are frequent, with an average duration of 7-10 months.

  • Exchange rate depreciation and oil price deviations from trend affect IT performance.


Conclusions1
Conclusions IT accuracy?

  • Stronger credibility and/or institutional perception, reflected either by CBI, sovereign spreads, or country credit rating enhances IT accuracy, even controlling for possible endogeneity.

  • Results show that institutional perception / credibility gains lead to statistically and economically significant improvements in IT accuracy.


By how much and why do inflation targeters miss their targets1

¿By How Much and Why Do Inflation Targeters Miss Their Targets?

Elías Albagli

Klaus Schmidt-Hebbel

Central Bank of Chile

Atlanta Fed Conference on “Implementing Monetary Policy in the Americas: The Role of Inflation Targeting

Atlanta, 4 October 2004


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