Revisiting the Nexus Between Inflation Targeting and the Build-Up of the Financial Imbalances

Abstract

The outbreak of the recent global financial crisis in 2007-2008 of the most developed economies, has spurred criticism that inflation targeting central banks may have neglected the build-up of financial imbalances. In other words the global financial and economic crisis highlights that central banks should be more effective in mastering financial instability, and should achieve an explicit goal of financial stability beyond their traditional emphasis on low inflation. In this paper, we aim to assess whether inflation targeting (IT) actually mattered as regards financial stability. Our empirical evidence has been conducted on a group of 41 emerging economies from which 20 economies adopt Inflation Targeting policy and 21 non Inflation Targeting economies as a group of control, over the period 2000-2017. To do this, we evaluate the time varying treatment effect of the IT's adoption on the banking system stability. Additionally using a variety of propensity score matching methods, we show that, on average inflation targeting has an insignificant effect on lowering banking system instability.