Inflation targeting and interest rates

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 over the 1975-2009 years, 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. Our findings are supportive of the optimistic view on IT, indicating that adoption of this monetary regime leads to lower nominal interest rates.