How Are Inflation Targets Set?

Authors


  • We thank the editor, anonymous referees, Ansgar Belke, Colin Cameron, Falko Fecht, Tomáš Holub, Július Horváth, Michal Kejak, Evžen Kočenda, Axel Lindner, Lubomír Lízal, Lucjan Orlowski, Jakub Seidler, Kateřina Šmídková and the seminar participants at the Czech National Bank, Charles University and the 8th Workshop on Monetary and Financial Economics (Halle, Germany) for helpful comments. All remaining errors are the responsibility of the authors. The views presented here do not necessarily represent those of the Czech National Bank. We acknowledge the support from the Grant Agency of the Czech Republic P402/10/0448. The questionnaire that was sent to all central banks in our sample is available upon request.

Roman Horváth

Institute of Economic Studies

Faculty of Social Sciences

Charles University

Opletalova 26

Prague 1

115 03

Czech Republic

roman.horvath@gmail.com

Abstract

This paper contributes to a better understanding of how inflation targets are set. First, we gather evidence on how inflation targets are set from official central bank and government publications, and from a questionnaire of our own design. Second, we estimate what determines the level of the inflation target in 19 inflation-targeting countries by using unbalanced panel interval regressions to deal with the issue that targets are typically set as a range rather than a point. We find that a higher target is associated with a higher level and variability of inflation. The setting of the inflation target is also found to have an important international dimension because higher world inflation is positively correlated with inflation targets. Rapidly growing countries exhibit higher inflation targets. Our results also show that authorities establish a wider target range for the inflation rate when the macroeconomic environment is less stable. We find that central bank credibility is negatively associated with the level of the inflation target, suggesting that less-credible central banks are likely to recognize the risks related to anchoring inflation expectations at low levels. On the other hand, government party orientation does not matter, even in less-independent central banks.

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