Dynamic central bank independence indices and inflation rate: A new empirical exploration

It has been argued that economies with more independent central banks experience lower inflation over time. In this paper we show that this relationship is sensitive to the methodology through which central bank independence indices are constructed. We stress the importance of employing dynamic central bank independence indices in two ways. First, we perform unit root tests with structural breaks to verify if the implementation of central bank reforms represents a structural break for the inflation rate dynamics. Second, we implement a panel data analysis.We find evidence that legislative reforms that modify the degree of independence of a central bank have a strong impact on the inflation rate dynamics. Moreover, underlying the importance of employing dynamic central bank independence indices, we confirm the negative relationship between the latter and inflation for a sample of 10 OECD countries.     

Inflation targeting makes the difference: Novel evidence on inflation stabilization

Though 28 and 29 provides theoretical evidence that the introduction of inflation targeting is consistent with an inflation stabilizing monetary policy, empirical evidence that the introduction of inflation targeting actually changes central bank’s behavior is still missing. This paper aims to close this gap and estimates forward-looking monetary policy rules for 20 inflation targeting countries. To this end, we use a data set which is available to the central bank in real-time, published on a frequently basis, comparable among all countries, and which includes the periods before and after the introduction of inflation targeting. We find that the introduction of inflation targeting significantly shifts the central bank’s reaction function toward inflation stabilizing. We also provide evidence of time-varying effects and find that central banks stabilize inflation once inflation targeting is introduced. We take our results as strong evidence that the introduction of inflation targeting makes the difference for monetary policy strategies.     

Inflation Targeting Matters: Evidence from OECD Economies' Sacrifice Ratios

Using data from OECD economies, we show that inflation targeters suffered smaller output losses during disinflations when compared to nontargeters. We also study why some countries choose to inflation target while others do not and find that higher average inflation and smaller debt levels render the adoption of the regime more likely. Applying Heckman's procedure to control for selection bias does not alter the link between inflation targeting and less costly disinflations.     

The Impact of Central Bank Independence on Political Monetary Cycles in Advanced and Developing Nations

This paper examines the extent to which monetary policy is manipulated for political purposes during elections. We do not detect political monetary cycles in advanced countries or developing nations with independent central banks. We do find evidence, however, in developing countries that lack central bank independence. Furthermore, we find some evidence that these cycles are not caused by monetization of election-related fiscal expansions. This suggests that pressure by politicians on the central bank to exploit the Phillips curve may be an important factor in generating political monetary cycles.     

Political monetary cycles and a de facto ranking of central bank independence

Political monetary cycles are less likely to occur in countries with independent central banks. Independent central banks can withstand political pressure to stimulate the economy before elections or finance election-related increases in government spending. Based on this logic and supporting evidence, we construct a de facto ranking of central bank independence derived from the extent to which monetary policy varies with the electoral cycle. The ranking avoids well-known problems with existing measures of central bank independence and provides independent information about average inflation and inflation volatility differences across countries.     

Does inflation targeting really make a difference? Evaluating the treatment effect of inflation targeting in seven industrial countries

We evaluate the treatment effect of inflation targeting in seven industrial countries that adopted this policy in the 1990s. To address the self-selection problem of policy adoption, we make use of a variety of propensity score matching methods recently developed in the treatment effect literature. Our results show that inflation targeting has no significant effects on either inflation or inflation variability in these seven countries. Further evidence from long-term nominal interest rates and income velocity of money also supports the window-dressing view of inflation targeting.     

Does Inflation Targeting Affect the Dispersion of Inflation Expectations?

In this paper, we examine the effect of having an inflation targeting framework on the dispersion of inflation forecasts from professional forecasters. We use a panel data set of 25 countries—including 14 inflation targeters—with 16 years of monthly information. We find that the dispersion of long-run inflation expectations is smaller in targeting regimes after controlling for country-specific effects, time-specific effects, the level and the variance of inflation, disinflation periods, and global inflation. On average, the full effect is not observed until the third year after implementation of inflation targeting. When we differentiate between developed and developing countries, the dispersion of inflation expectations after inflation targeting is smaller and statistically significant only in developing countries.     

Inflation targeting,credibility, and non-linear Taylor rules

In this paper we systematically evaluate how central banks respond to deviations from the inflation target. We present a stylized New Keynesian model in which agents' inflation expectations are sensitive to deviations from the inflation target. To (re-) establish credibility, monetary policy under discretion sets higher interest rates today if average inflation exceeded the target in the past. Moreover, the central bank responds non-linearly to past inflation gaps. This is reflected in an additional term in the central bank's instrument rule, which we refer to as the ”credibility loss.” Augmenting a standard Taylor (1993) rule with the latter term, we provide empirical evidence for the interest rate response for a sample of five inflation targeting (IT) economies. We find, first, that past deviations from IT feed back into the reaction function and that this influence is economically meaningful. Deterioration in credibility (ceteris paribus) forces central bankers to undertake larger interest rate steps. Second, we detect an asymmetric reaction to positive and negative credibility losses, with the latter dominating the former.     

Foreign bank penetration and the lending channel in emerging economies: Evidence from bank-level panel data

This paper examines the main implications of recently increasing foreign bank penetration on bank lending as a channel of monetary policy transmission in emerging economies. Using a dynamic panel model of loan growth, we investigate the loan granting behavior of 1273 banks in the emerging economies of Asia, Latin America, and Central and Eastern Europe during the period from 1996 to 2003. Applying the pooled OLS, system GMM, and panel VAR estimators, we find consistent evidence that foreign banks are less responsive to monetary shocks in host countries, as they adjust their outstanding loan portfolios and interest rates to a lesser extent than domestic private banks, independent of their liquidity, capitalization, size, efficiency, and credit risk, and although there exists a bank lending channel in the emerging economies, it is declining in strength due to the increased level of foreign bank penetration. We also explore possible driving factors for the different responses of foreign and domestic banks to monetary policy shocks by investigating foreign banks’ different behavior during banking crises and tranquil periods, the effects of mode of entry to host countries, the home-country effects, and the response of foreign banks from OECD countries vs. all foreign countries including non-OECD countries. We suggest the access of foreign banks to funding from parent banks through internal capital markets as the most convincing explanation.     

The housing price boom of the late 1990s: Did inflation targeting matter?

The recent boom in the housing markets of most developed economies has spurred criticism that inflation targeting central banks may have neglected the build-up of financial imbalances. This paper provides a formal empirical test of such claims, using a standard program evaluation methodology to control for a possible bias due to self-selection into inflation targeting. We consider 17 industrial economies over the period 1980–2007, among which nine countries have targeted inflation at some point. We find robust evidence of a significant positive effect of inflation targeting on real house price growth and on the house price-to-rent ratio.     

Does Inflation Targeting Help Reduce Financial Dollarization?

We examine whether adopting an inflation‐targeting regime helps reduce financial dollarization as predicted by Ize and Levy Yeyati's ( 2003 ) portfolio model. To address the self‐selection problem of policy adoption, we apply a variety of propensity score matching methods to a large sample of 106 developing countries for the years 1985–2004. We find strong evidence that inflation targeting has large and significant treatment effects on lowering both actual financial dollarization and the model implied minimum variance portfolio dollarization. Our results are robust to alternative samples and model specifications and also to control for additional factors in postmatching regressions.     

Sovereign debt risk in emerging market economies: Does inflation targeting adoption make any difference?

Based on a sample of 38 emerging economies, we find that inflation targeting (IT) adoption improves sovereign debt risk. Next, we show that this favorable effect is sensitive to several structural characteristics, and to the considered time span. Finally, the measure of sovereign risk (sovereign debt ratings or government bond yield spreads) and the IT form (full-fledged or partial) equally influence the effect of IT adoption on sovereign debt risk. Thus, our paper provides valuable insights regarding IT implementation as a device for improving emerging market economies' access to international financial markets.     

Inflation targeting and the forward bias puzzle in emerging countries

Based on quarterly data on 31 emerging countries (among which 16 are inflation targeting countries) from 1990Q1 to 2014Q3, we obtain a strong support for the conjecture that the implementation of inflation targeting weakens the Fisherian relation between expected depreciation and the interest rate differential (uncovered interest parity condition) and thus is conducive to the appearance of the forward bias puzzle in emerging countries. We show that this reflects the performance of inflation targeting regimes in lowering the level and volatility of inflation. Our finding holds when controlling for country-specific effects, time-specific effects, global disinflation, exchange rate management, crises, and using different econometric techniques.     

Measuring the Independence of Central Banks and Its Effect on Policy Outcomes

Making the central bank an agency with the mandate and reputationfor maintaining price stability is a means by which a governmentcan choose the strength of its commitment to price stability.This article develops four measures of central bank independenceand explores their relation with inflation outcomes. An aggregatelegal index is developed for four decades in 72 countries. Threeindicators of actual independence are developed: the rate ofturnover of central bank governors, an index based on a questionnaireanswered by specialists in 23 countries, and an aggregationof the legal index and the rate of turnover. Legal independence is inversely related to inflation in industrial,but not in developing, countries. In developing countries theactual frequency of change of the chief executive officer ofthe bank is a better proxy for central bank independence. Aninflation-based index of overall central bank independence contributessignificantly to explaining cross-country variations in therate of inflation.     

INTERNATIONAL BANK FLOWS TO EMERGING MARKETS: INFLUENCE OF SOVEREIGN CREDIT RATINGS AND THEIR REGIONAL SPILLOVER EFFECTS

We examine whether changes in sovereign credit assessments help determine international bank flows to emerging countries. We focus on the bank flows of G7 countries to a sample of 55 emerging market borrowers for 1995–2008. We find evidence indicating that sovereign credit rating revisions have significant and positive influences on international bank flows from developed markets even after controlling for other determinants. In addition, we find strong regional rating spillover effects. Ratings improvements in one emerging market region tend to reduce bank flows to the other regions. However, there is an exception from the Asia Pacific to Eastern Europe.     

Does inflation targeting improve fiscal discipline?

We explore the performances of inflation targeting (IT) adoption in terms of fiscal discipline (FD), while most existing studies focus exclusively on the role of FD as a precondition for IT adoption. Using a sample of developing and developed countries, we show that IT adoption exerts a positive and significant effect on FD, a result robust to a wide variety of alternative specifications. In addition, this effect is statistically significant only in developing countries, a result that may fuel the current debate regarding the relevance of IT adoption in general, and particularly for developing countries.     

Central bank financial strength and inflation: Is there a robust link?

Central bank financial strength has not been a fundamental issue for a substantial period of time. However, recent theoretical and empirical studies argue that central banks need to maintain a sufficient level of financial strength to perform their functions effectively and to achieve monetary policy objectives. In this study, we examine the empirical relationship between central bank financial strength and inflation using an unbalanced panel data set for a sample of selected advanced and emerging countries. We observe a statistically significant and robust negative relationship between central bank financial strength and inflation. This relationship is robust in the presence of other determinants of inflation and for alternative estimation methods. Our results have important implications for policy makers and central bankers. Particularly, our results suggest that avoiding persistent losses and maintaining the health of the central bank balance sheet remain vital pre-conditions for desirable policy outcomes of a central bank.     

Global Liquidity,House Prices,and the Macroeconomy: Evidence from Advanced and Emerging Economies

In this paper, we first compare house price cycles in advanced and emerging economies using a new quarterly house price data set covering the period 1990–2012. We find that house prices in emerging economies grow faster, are more volatile, less persistent, and less synchronized across countries than in advanced economies (AEs). We also find that they correlate with capital flows more closely than in AEs. We then condition the analysis on an exogenous change to a particular component of capital flows: global liquidity, broadly understood as a proxy for the international supply of credit. We identify this shock by aggregating bank‐to‐bank cross‐border credit and by using the external instrumental variable approach introduced by Stock and Watson (2012) and Mertens and Ravn (2013). We find that in emerging markets (EMs) a global liquidity shock has a much stronger impact on house prices and consumption than in AEs. We finally show that holding house prices constant in response to this shock tends to dampen its effects on consumption in both AEs and EMs, but possibly through different channels: in AEs by boosting the value of housing collateral and hence supporting domestic borrowing; in EMs, by appreciating the exchange rate and hence supporting the international borrowing capacity of the economy.     

The Banking Sector,Government Bonds,and Financial Intermediation: The Case of Emerging Market Countries

This paper develops an analytical framework to explore how financial-sector characteristics shape the terms and the scale of public borrowing in emerging market economies. We find that the more competitive the banking sector and the more liquid and deeper the deposit market, the better are conditions in the public securities market. We also show that the greater the central bank independence, the higher the cost of public borrowing. Furthermore, our results suggest that, in countries where banks rely significantly on foreign currency financing, the greater the government's reliance on bank lending, the greater is its exposure to exchange rate risk.     

Optimal monetary policy under low trend inflation

In the monetary policy literature it is common to assume that trend inflation is zero, despite overwhelming evidence that zero inflation is neither empirically relevant nor a practical objective for central bank policy. We therefore extend the standard New Keynesian model to allow for positive trend inflation, showing that even low trend inflation has strong effects on optimal monetary policy and the dynamics of inflation, output and interest rates. Under discretion, the efficient policy deteriorates and there is no guarantee of determinacy. Even with commitment, targeting non-zero trend inflation leads to substantial welfare losses. Our results serve as a warning against indiscriminate use of models assuming zero trend inflation.