Monetary Institutions, Partisanship, and Inflation Targeting

1. Monetary Institutions, Partisanship, and Inflation Targeting presented by David Andrew Singer Massachusetts Institute of Technology co-author: Bumba Mukherjee Princeton/University of Notre Dame IPES November 18, 2006

2. Inflation Targeting (IT): A Nominal Anchor for Monetary Policy • Numerically specified target for inflation • Public commitment to price stability • Requires transparency and publication of inflation forecasts • Since 1989, 25 countries have adopted IT • The “monetary framework of choice” for LDCs (IMF 2006); Ben Bernanke also an advocate David Andrew Singer MIT

3. Table 2: Inflation Targeting Countries (as of 2003) Source: Truman (2003). The Slovak Republic, Indonesia, and Romania adopted IT in 2005. Finland and Spain joined the EMU in 1999 and no longer have autonomous monetary policies.

4. Research Question • Why do some countries adopt IT, while others do not? • Importance: • Declining popularity of fixed exchange rates • Alternative nominal anchors (e.g., money targets) largely discredited • Is central bank independence sufficient to fight inflation? David Andrew Singer MIT

5. Open Economy Monetary Policy Model • Two actors: government and central bank • Government’s loss function (based on Barro & Gordon 1983; Persson & Tabellini 2000) • Inflation vs. output deviation • Our key modification: partisanship (L,R) determines degree of inflation aversion (θ) David Andrew Singer MIT

6. Model (continued) • Central bank’s loss function: • Assume IT as an inflation-fighting option • Innovation: allow central bank’s inflation preferences to vary as a function of its regulatory mandate • Central bank regulators more sensitive to financial stability, less likely to enact tight monetary policy (Copelovitch and Singer 2006) • λ = 1 if central bank and bank regulator are separated David Andrew Singer MIT

7. Observable Implication • Adoption of IT more likely when right-leaning government and central bank not a regulator • Compatibility of preferences between government and central bank over inflation David Andrew Singer MIT

8. Two Empirical Analyses • First analysis: Markov transition model to explain adoption of IT • Captures the effect of IVs on probability of adopting IT, and conditional probability of maintaining IT • [Second analysis: parametric and non-parametric models to explore impact of IT on inflation] David Andrew Singer MIT

9. Markov Model: Data and Variables • Sample: 49 countries, 1987-2003 • DV: dichotomous (IT=1, 0 otherwise) • IVs: • Central bank mandate (regulator=0, separate=1) • Partisanship • CBI • Polity, veto players • Exch rate regime and variability • Economic controls interaction David Andrew Singer MIT

10. See paper for full regression table

11. Findings • Right government + non-regulatory central bank increases likelihood of adopting IT • When separate CB, one std. dev change in partisanship (toward the right) increases probability by 35% • Additional finding: IT reduces inflation (see paper) David Andrew Singer MIT