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Inflation Targeting as a Shock Absorber

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  • Marcel Fratzscher
  • Christoph Grosse Steffen
  • Malte Rieth

Abstract

We study the characteristics of inflation targeting as a shock absorber, using quarterly data for a large panel of countries. To overcome an endogeneity problem between monetary regimes and the likelihood of crises, we propose to study large natural disasters. We find that inflation targeting improves macroeconomic performance following such exogenous shocks. It lowers inflation, raises output growth, and reduces inflation and growth variability compared to alternative monetary regimes. This performance is mostly due to a different response of monetary policy and fiscal policy under inflation targeting. Finally, we show that only hard but not soft targeting reaps the fruits: deeds, not words, matter for successful monetary stabilization.

Suggested Citation

  • Marcel Fratzscher & Christoph Grosse Steffen & Malte Rieth, 2018. "Inflation Targeting as a Shock Absorber," Discussion Papers of DIW Berlin 1721, DIW Berlin, German Institute for Economic Research.
  • Handle: RePEc:diw:diwwpp:dp1721
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    Keywords

    Monetary Policy; Central Banks; Monetary Regimes; Dynamic Effects;

    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

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