The Impact of Inflation Targeting: Testing the Good Luck Hypothesis
AbstractOver the last twenty years the level and volatility of inflation decreased across industrial countries. The inflation stabilization can be explained by a shift in monetary policy or by a lucky period of low volatility in business cycle shocks. To test the “luck hypothesis” we examine the inflation experience of Canada, one of the earliest and most successful adopters of an inflation targeting monetary policy. We Kalman-filter the historical structural shocks consistent with an estimated DSGE model. The estimated shocks are used to build counterfactual histories. Ex-ante the model predicts inflation volatility to more than halve under inflation targeting. But conditional on the shocks, we show that the luck hypothesis can explain with a high probability Canada’s low inflation volatility since the early 1990s. Any inflation stabilization induced by the shift in policy is accounted for the most part by the impact on expectations. Counterfactuals built neglecting expectations would prove the inflation targeting policy irrelevant.
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Bibliographic InfoPaper provided by CIRPEE in its series Cahiers de recherche with number 1029.
Date of creation: 2010
Date of revision:
Business cycle shocks; Kalman filter; Credibility; Inflation targeting;
Find related papers by JEL classification:
- E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-09-18 (All new papers)
- NEP-CBA-2010-09-18 (Central Banking)
- NEP-DGE-2010-09-18 (Dynamic General Equilibrium)
- NEP-MAC-2010-09-18 (Macroeconomics)
- NEP-MIC-2010-09-18 (Microeconomics)
- NEP-MON-2010-09-18 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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