Inflation and Macroeconomic Effects of Inflation Targeting in Asia: Time-Series and Cross-Country Analysis

Abstract

Controlling inflation is important. The 2008-2009 global financial crisis created new concerns about the macroeconomic effects of inflation targeting. A key issue for many central banks in recent years has been that inflation is uncomfortably too low rather than too high. This thesis examines the impact of inflation targeting on the behaviour of inflation, output growth and real exchange rates for eight Asian countries using time-series and panel data from 1987 to 2013. The econometric methodologies employed include panel GARCH, quantile unit root and Markov regime-switching testing. Panel GARCH results indicate that inflation targeting is more credible in lowering the inflation level rather than its volatility. The quantile unit root testing results indicate that the credibility of inflation targeting and alternative monetary policy frameworks in Asia are imperfect, except for Malaysia and South Korea. Results also suggest that targeting countries have been building up their monetary policy credibility more than non-targeting countries, based on a faster rate of decline in inflation rate changes. Results generally indicate the presence of mean-reversion at the lower quantiles only. Where stationarity is present, results indicate varied speed of adjustment process across quantiles. The regime-switching results indicate that inflation and output growth are generally characterized by partial stationarity, while there is mostly varied stationarity in real exchange rates. Results also indicate that inflation targeting significantly affects the inferred probabilities of remaining in the stationary regime, mainly for output growth and real exchange rates and for inflation in some cases. Results further indicate that the variance of inflation and output growth is lower during the inflation targeting period. Furthermore, results indicate that there is a significant difference between targeting and non-targeting countries in terms of the speed of adjustment of macroeconomic variables towards the equilibrium level and the behaviour of inferred probabilities of remaining in the stationary regime.