Has Inflation Targeting Improved Monetary Policy? Evaluating Policy Effectiveness in Australia, Canada, and New Zealand

Doubts continue to be expressed about the net benefits of announcing an explicit inflation objective versus a more balanced set of goals that include an overt concern over real economic developments. This is true even if major central banks that do not explicitly target inflation (e.g., the US Fed, the ECB) emphasize the primacy of price stability as the sine qua non of monetary policy.We estimate a canonical macro model for each one of the three countries considered to be at the vanguard of the inflation targeting policy strategy, namely Australia, Canada, and New Zealand, and use the resulting estimates to derive measures of inflation pressure relying on two counterfactual experiments. The first asks what inflation would be if the monetary policy instrument had remained unchanged. Next, we ask what inflation rate would be obtained if the actual policy implemented by the central bank had been a surprise. Comparisons of the two scenarios suggest an indicator of monetary policy effectiveness. We also contrast our findings with evidence from the US (Siklos and Weymark 2008). Briefly, we find that, in all three of inflation targeting economies, the policy regime has succeeded in keeping inflation pressure substantially lower than in the US. In addition, inflation targeting central banks are less likely to require changes in the policy rate to accomplish a given reduction in inflation pressure than does the U.S. Federal Reserve