Inflation targeting and income velocity in developing economies: Some international evidence

Developing economies tend to prefer or rely upon monetary policy rule with monetary aggregates due to institutional constraints on monetary policy conduct. One crucial condition for monetary aggregates to be a sound instrument is the stability of income velocity. Recently, inflation targeting has been adopted as an alternative monetary policy framework in various developing countries. This study attempts to examine how inflation targeting relates to the variability of income velocity and its components across 84 developing countries during the period from 1990 to 2013. The results suggest that inflation targeting would help stabilize income velocity in developing countries. In addition, a decomposition analysis of income velocity generally shows that inflation targeting would reduce the volatilities of inflation, real output growth, and money growth. Our results provide empirical support for the argument that stable income velocity associated with inflation targeting could improve the effectiveness of monetarism, such that monetary aggregates can serve as an appropriate instrument under inflation targeting regime in developing countries.