Inflation targeting: an indirect approach to assess the direct impact

Abstract

It is quite difficult to assess the benefits of inflation targeting (IT) since its immediate effect will be on inflation expectations, an unobserved variable. Due to lack of comprehensive data on inflation expectations, most studies so far concentrated on the impact of IT either on observable variables like output, unemployment, and inflation or compared post-IT surveys of IT countries with non-IT countries. In our study, we focus on a yet unanswered question, i.e., how the expectations change with the adoption of IT. We suggest that heterogeneous inflation expectations lead to long memory in actual inflation, and IT, if successful, should decrease this persistence by concentrating the public's expectations toward the announced target. Empirical results confirm our hypothesis with a reduction in inflation memory after the adoption of IT in almost all eight developed countries in our sample. © 2010 Elsevier Ltd.