Does Talk Matter after All? : Inflation Targeting and Central Bank Behavior

Interpretations of inflation targeting (IT) have ranged widely, from "inflation-only targeting" without regard for output, to cheap talk without effect, to transparency increasing flexibility without cost. We characterize five interpretations of the adoption of IT as shifts between strategies in a conventional model of monetary time-inconsistency. Their implications for central bank behavior are compared to the time-series properties of inflation, and to the response of interest rates to inflation movements, for three countries adopting IT in the early 1990s. For the U.K. and Canada, lower inflation levels and persistence post-adoption are combined with greater accommodation of real shocks and more stable private-sector inflation expectations. This is consistent with successful approximation of the optimal state-contingent rule. The results for New Zealand post adoption mix reduced inflation level and persistence with less stable inflation expectations, perhaps reflecting increased rule-like conservatism. There is no evidence, however, that IT entails a single-minded pursuit of the inflation target