ECB study finds inflation targets do work

A recently published working paper by the European Central Bank investigates the impact of inflation targeting, and concludes that explicit inflation targets do have a significant effect.

Despite the increasing popularity of explicit inflation targets among central banks, and the many theoretical studies on their advantages, the paper suggests that until now there has been little empirical evidence on their macroeconomic benefits.

By comparing five industrialised countries with explicit inflation targeting regimes, and seven without, the study was able to demonstrate the effects on inflation expectations and persistence.

It found that a target provides a good anchor for market expectations of inflation. Without a target, forecasts correlated with a three-year moving average of lagged inflation, but with a target this correlation was absent, said the paper. This implies that targets have been successful in delinking expectations from realized inflation, it claimed.

It also found that targets leads to lower persistence of inflation, with it exhibiting less random walk characteristics than otherwise.

The analysis of emerging markets was less conclusive, but supported earlier studies showing that the adoption of a target has little initial effect on market expectations until the regime can prove itself and overcome skepticism.

Click here to read the paper