Inflation targeting and interest rates: a panel time-series approach

Abstract

Inflation Targeting (IT) can be expected to play a role in structurally reducing nominal interest rates by lowering a country’s inflation expectations and risk premium. Relying on a panel of 52 advanced and emerging economies from 1975–2009, we carry out a formal investigation of this hypothesis. Our econometric strategy adopts a flexible and efficient panel estimation framework, controlling for a number of issues usually neglected in the literature, such as parameter heterogeneity and cross-section dependence. The empirical analysis is based on a dynamic model. Our findings are supportive of a view that, on average, IT leads to a reduction of short- and long-term nominal interest rates.

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