Financial development and inflation targeting: How market structure shapes monetary policy effectiveness

This study examines how financial development shapes monetary policy effectiveness and the role of inflation targeting in this relationship. Prior research has explored the effects of financial development on policy transmission and inflation targeting separately, but evidence on their interaction remains scarce. Using a dynamic panel of 126 countries from 1995 to 2021, we apply System-Generalised Method of Moments estimation to assess how evolving financial structures condition monetary outcomes. The results show that as financial markets become more efficient, price-based policy tools gain traction while quantity-based channels weaken. The components of financial development have divergent effects on inflation: institutional efficiency raises inflation, while institutional depth and market efficiency help to contain it. We also find that inflation-targeting frameworks reduce inflation more effectively when supported by developed financial systems. These findings underline the importance of aligning monetary frameworks with financial structures, offering policy lessons for emerging economies integrating financial reforms with inflation-targeting strategies.