The performance of inflation targeting regimes in emerging and developing countries: A propensity score matching approach

Inflation targeting (IT) is a widely used monetary policy. We examine the effects of it on emerging and developing countries’ inflation, output growth, dollarization, real effective exchange rate (REER), REER volatility, fiscal balance, output volatility and inflation volatility via propensity score matching. Propensity score matching is based on matching IT adopters and non-IT adopters on their propensity scores. The mean difference of the outcomes between these two is the average treatment effect (ATT). The main aim of it is to solve the self-selection problem. Propensity scores indicate the likelihood of adaptation of IT and these can be estimated via a probit model. In our main analysis, there is evidence of a decrease in inflation after the introduction of IT. Note that there is a decrease in GDP growth. Moreover, there is a decrease in REER suggesting there is a depreciation. The increase in fiscal balance implies the government becomes more efficient in tax collection to compensate the loss of the seignorage income. There is also an increase in GDP per capita volatility and GDP volatility. Our results are robust to different probit model specifications. By moving beyond inflation outcomes alone, this study provides new empirical evidence on the broader macroeconomic trade-offs associated with IT adoption in emerging and developing countries. The findings highlight that IT must be supported by institutional and structural reforms to achieve stable growth in these economies.