Transitions to Inflation Targeting: Panel Evidence

From panel estimates of an extended version of the Taylor-rule reaction function that adds lagged inflation, output gaps and exchange rates, we confirm that inflation is more central to the setting of policy interest rate when emerging market economies’ (EMEs) central banks follow inflation targeting (IT), while the exchange rate carries more weight for non-IT EMEs. Moreover, lagged output gaps are also play important roles in setting policy interest rates in IT EMEs. Employing a volatility measurement approach, our analysis also confirms that IT does moderate the volatility of inflation and exacerbate that of nominal exchange rates. Yet IT appears less effective in controlling the volatility of real variables, including output volumes.