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


Inflation convergence under it

Inflation convergence under IT


Inflation convergence under it1

Inflation convergence under IT


By how much and why do inflation targeters miss their targets

Inflation convergence under IT


This paper s objectives

This paper’s objectives:

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.


1 measuring inflation targeting accuracy

1. Measuring Inflation Targeting Accuracy


By how much and why do inflation targeters miss their targets

  • Data and methodology

    • 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).


Alternative monthly targets chile

Alternative monthly targets: Chile


Alternative monthly targets israel

Alternative monthly targets: Israel


By how much and why do inflation targeters miss their targets

  • Descriptive statistics of target accuracy

    • Mean absolute deviation

    • Normalized mean absolute deviation

    • Deviations’ persistence (half-life inflation shocks)

    • Large inflation deviation episodes:


Large inflation deviation episodes

Large inflation deviation episodes

*Target: IPT


It accuracy results

IT Accuracy: Results


It accuracy results1

IT Accuracy: Results


It accuracy rankings

IT Accuracy: Rankings


2 what explains it accuracy

2. ¿What explains IT Accuracy?


By how much and why do inflation targeters miss their targets

  • 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.


By how much and why do inflation targeters miss their targets

  • Previous findings:

    • 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.


By how much and why do inflation targeters miss their targets

  • This paper extends previous evidence in several dimensions:

    • 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).


By how much and why do inflation targeters miss their targets

  • Institutional Investor’s Country Credit Rating

    • 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.


By how much and why do inflation targeters miss their targets

  • Data and methodology:

    • 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).


By how much and why do inflation targeters miss their targets

  • Cross-section averages:

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


By how much and why do inflation targeters miss their targets

  • Panel data regressions

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).


Results gains in it accuracy

Results: Gains in IT Accuracy


Conclusions

Conclusions

  • 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

  • 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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