presented byDavid Andrew SingerMassachusetts Institute of

Technology

Monetary Institutions, Partisanship, and Inflation Targeting

co-author:Bumba Mukherjee

Princeton/University of Notre Dame

IPESNovember 18, 2006

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Inflation Targeting (IT): A Nominal Anchor for Monetary Policy

Numerically specified target for inflation– Public commitment to price stability– Requires transparency and publication of inflation forecasts

Since 1989, 25 countries have adopted IT

The “monetary framework of choice” for LDCs (IMF 2006); Ben Bernanke also an advocate

David Andrew SingerMIT

Table 2: Inflation Targeting Countries (as of 2003)

Country Adoption Date

Country Adoption Date

Australia 1993 Mexico 1995

Brazil 1999 New Zealand

1989

Canada 1991 Norway 2001

Chile 1990 Peru 2002

Colombia 1999 Philippines

2002

Czech Rep. 1997 Poland 1998

Finland 1993 S. Africa 2000

Hungary 2001 Spain 1995

Iceland 2001 Sweden 1993

Israel 1991 Thailand 2000

Korea 1998 U.K. 1992

Source: Truman (2003). The Slovak Republic, Indonesia, and Romaniaadopted IT in 2005. Finland and Spain joined the EMU in 1999 and no longerhave autonomous monetary policies.

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Research Question

Why do some countries adopt IT, while others do not?

Importance:– Declining popularity of fixed exchange rates– Alternative nominal anchors (e.g., money targets) largely

discredited– Is central bank independence sufficient to fight inflation?

David Andrew SingerMIT

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Open Economy Monetary Policy Model

Two actors: government and central bank Government’s loss function (based on Barro &

Gordon 1983; Persson & Tabellini 2000)– Inflation vs. output deviation– Our key modification: partisanship (L,R) determines degree

of inflation aversion (θ)

LG 1

2[(y y )2 G

2 ] y 0, G L,R

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Model (continued)

Central bank’s loss function:– Assume IT as an inflation-fighting option– Innovation: allow central bank’s inflation preferences to vary

as a function of its regulatory mandate Central bank regulators more sensitive to financial

stability, less likely to enact tight monetary policy (Copelovitch and Singer 2006)

λ = 1 if central bank and bank regulator are separated

] ))(())(1[(2

1 22 TGCB yyL

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Observable Implication

Adoption of IT more likely when right-leaning government and central bank not a regulator

– Compatibility of preferences between government and central bank over inflation

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Two Empirical Analyses

First analysis: Markov transition model to explain adoption of IT

– Captures the effect of IVs on probability of adopting IT, and conditional probability of maintaining IT

[Second analysis: parametric and non-parametric models to explore impact of IT on inflation]

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Markov Model: Data and Variables

Sample: 49 countries, 1987-2003 DV: dichotomous (IT=1, 0 otherwise) IVs:

– Central bank mandate (regulator=0, separate=1)– Partisanship– CBI– Polity, veto players– Exch rate regime and variability– Economic controls

interaction

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Model 1 Model 2 Model 3

Covariates

GDP Growth variability .035***(.011)

.031***(.012)

.045***(.020)

.040**(.019)

.039*** (.015)

.058***(.014)

Real Interest Rate .050***(.022)

.059***(.021)

.043***(.020)

.057***(.022)

.061***(.022)

.055***(.021)

Nominal Interest rate .068(.074)

-.065(.092)

.073 (.058)

-.062(.049)

.050(.062)

-.069(.070)

Trade Openness .038(.144)

-.071(.088)

.060(.118)

-.075(.073)

.022(.145)

-.058(.087)

REER variability .039*** (.018)

.032***(.010)

.020***(.008)

.024***(.007)

.043***(.012)

.035***(.014)

NEER variability .024(.028)

-.031(.030)

.023(.020)

-.035(.028)

.035(.030)

-.025(.032)

Current Account -.022**(.011)

-.036**(.017)

-.055*(.030)

-.072*(.041)

-.045**(.018)

-.038**(.019)

CBI .030(.071)

.039(.050)

.029(.020)

.033(.042)

.031(.026)

.044(.031)

Partisanship x Separate

.151***(.049)

.138***(.037)

.103***(.036)

.142***(.040)

.132***

(.036)

.114***

(.045)

Partisanship .021*(.012)

.032*(.018)

.034*(.019)

.022*(.013)

.023*(.014)

.024*(.014)

Separate Central Bank .051*(.030)

.045*(.024)

.043*(.027)

.040*(.024)

.041*(0.22)

.055*(.033)

0

0

0

1

1

1

See

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tabl

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Findings

Right government + non-regulatory central bank increases likelihood of adopting IT

– When separate CB, one std. dev change in partisanship (toward the right) increases probability by 35%

Additional finding: IT reduces inflation (see paper)

David Andrew SingerMIT