Inflation Targeting, Economic Growth and Financial Stability: Evidence from Emerging Countries

Abstract

Our aim of this paper is to determine whether inflation targeting could improve economic growth and financial stability in 35 emerging economies of which 19 inflation-targeting and 16 non-inflation-targeting countries over the 1995–2017 period. To this end, we first determine the preconditions needed to adopt the inflation targeting regime using the Qualitative Comparative Analysis method (QCA). We then construct a Financial Stability Index (FSI) for emerging markets using a Principal Components Analysis (PCA). Finally, we determine the impact of shocks on economic growth and financial stability in inflation-targeting and non-inflation-targeting countries through a Panel VAR model estimated using the GMM method. The results show that some structural and institutional preconditions, should be set up during the pre-adoption period. In addition, the results indicate that the inflation-targeting regime allows emerging countries to control their economic growth and financial stability in the event of shocks to a greater extent than non-targeting countries, although the magnitude of the shock persists only in the short run, given that economic and financial conditions return to their normal state in the long run.

Keywords

• inflation targeting
• financial stability
• economic growth
• shock analysis
• qca
• p-var