۱- Introduction

۲- Empirical analysis

۳- Analytical illustration

۴- Conclusion

References

Abstract

Under inflation targeting, central banks are supposed to set an inflation target in advance and then try to make the actual inflation reach the target. However, central banks may have an incentive to adjust their targets to meet their goals. Panel data analysis with a sample of 19 inflation-targeting countries show that changes in the inflation target significantly and positively respond to the deviation of the inflation rate from the target in the previous period. This result supports the idea that inflation-targeting central banks adjust the inflation target to meet the target when they miss it. Further analysis suggests that such a relationship is more evident in central banks with low credibility or weak performance compared with high credibility or strong performance. Finally, we show that such behavior of central banks can lead to equilibrium indeterminacy in the standard New Keynesian model. Further, such behavior renders achieving equilibrium determinacy harder for central banks even in more realistic models. This result may imply that when central banks respond to missed inflation targets by adjusting their targets and to enhance the credibility and stabilize the inflation rate, they may end up destabilizing inflation expectations and the inflation rate.

Introduction

Since New Zealand adopted inflation targeting in 1990, an increasing number of countries have adopted this policy as well. As a result, actual inflation rates in many economies, even emerging ones, have decreased sharply after the inflation targeting system was introduced. The inflation rate in our sample of 19 countries dropped by 9.3% points on average in 5 years after adopting inflation targeting. Although inflation targeting has been successful in reducing the inflation rate, the inflation-targeting central banks have not always been successful in meeting the inflation target. In our sample of 19 countries, the absolute value of deviation of the actual inflation rate from the target is 2.0% points at an annual average. This study aims to find out how inflation-targeting central banks behave when they miss the target. Particularly, do inflation-targeting central banks respond to misses on their targets by adjusting their targets to close the gap between the actual inflation rate and the inflation target? For example, in 2004, the Bank of Indonesia set the following three-year inflation target: 6 ± ۱% (۲۰۰۵), ۵٫۵ ± ۱% (۲۰۰۶), and 5 ± ۱% (۲۰۰۷). However, when the inflation rate departed from the upper bound of the target (10.5% in 2005), the Bank of Indonesia revised upwards the mid-point of the target by more than 1% point to 8 ± ۱% (۲۰۰۶), ۶ ± ۱% (۲۰۰۷), and 5 ± ۱% (۲۰۰۸) in 2005.