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Examining the success of the central banks in inflation targeting countries: the dynamics of the inflation gap and institutional characteristics

Omid M. Ardakani and N. Kundan Kishor


This paper analyzes the performance of the central banks in inflation targeting (IT) countries by examining their success in achieving their explicit inflation targets. For this purpose, we decompose the inflation gap, the difference between actual inflation and the inflation target, into predictable and unpredictable components. We argue that the central banks are successful if the predictable component diminishes over time. The predictable component of the inflation gap is measured by the conditional mean of a parsimonious time-varying autoregressive model. Our results find considerable heterogeneity in the success of these IT countries in achieving their targets at the start of this policy regime. Our findings suggest that the central banks of the IT adopting countries started targeting inflation implicitly before becoming an explicit inflation targeter. The panel data analysis suggests that the relative success of these countries in reducing the gap is influenced by their institutional characteristics, particularly fiscal discipline and macroeconomic performance.

JEL Classification: E52; E58; C32

Appendix A

This appendix shows how we constructed the central bank independence measure. Cukierman, Webb, and Neyapti (1994) develop four measures of central bank independence and find their correlation with the inflation outcomes. The legal index, the rate of turnover of central bank governors, an index based on a questionnaire answered by specialists and an aggregation of the legal index with the turnover rate. They conclude that the legal independence is negatively related to inflation in industrial countries, but not in developing countries. We consider the turnover of central bank governors as an index for central bank independence. The turnover rate is more accurate than the legal index or questionnaire based criterion in the emerging market economies, because the latter two indices are build upon central bank laws and they do not reflect the independence of the central bank.

We construct the index based on the findings of Cukierman, Webb, and Neyapti (1994) by assuming that above a threshold, a rapid turnover of central bank governors determines a higher dependence. If the political authorities frequently choose a new governor, they have the opportunity to pick those who favor the nominators’ will. Frequent turnover reflects firing those who challenge the government. This is true especially in developing countries. Therefore, the measure for this index is in accordance with the electoral cycle for the central banks. If the turnover of central bank governor is 4 years the index will be 0.25, and so on.

Using the turnover index, we find the central bank independence for all the inflation targeters. Table A presents the average annual turnover rates in our sample countries for two time periods, 1980–1999 and 2000–2013. The average annual turnover rates are calculated from the ratio of governor changes to the number of years in that period. The average turnover rate during 1980–1999 ranges from a minimum of 0.0 to a maximum of 0.2. An average turnover of 0.0 indicates no change in the last 20 years. Canada, Colombia, the Czech Republic, Hungary, and the United Kingdom are a few examples of totally independent structures. Countries such as Chile, Poland, and Turkey have the highest rates of dependency. The central banks’ independence has increased from the period 1980–1999 to 2000–2013. In the first period, there are five countries with totally independent central banks; whereas, after 2000 it has risen to 13 countries. The average annual turnover rate reduced significantly in 15 countries, i.e. the degree of central bank independence has been increasing over time.

Table A:

Average annual turnover rates of the central bank governors for the inflation targeters, 1980–2013.

Armenia0.100.07New Zealand0.150.07
Ghana0.150.21South Africa0.050.00
GuatemalaNANASouth Korea0.100.00

Appendix B

As a robustness check to the TVP model specification, we present the annualized conditional means of the inflation gap from the time-varying parameter autoregressive model of order 2. The results are presented in Figure 5. A comparison between this finding and the main results reported in Figure 5 indicates similar trends in the predictable component of the inflation gap.

Figure 5: Annualized conditional means of the inflation gap and residuals from the time-varying parameter autoregressive model (AR(2) Model).
Figure 5: Annualized conditional means of the inflation gap and residuals from the time-varying parameter autoregressive model (AR(2) Model).
Figure 5: Annualized conditional means of the inflation gap and residuals from the time-varying parameter autoregressive model (AR(2) Model).
Figure 5: Annualized conditional means of the inflation gap and residuals from the time-varying parameter autoregressive model (AR(2) Model).

Figure 5:

Annualized conditional means of the inflation gap and residuals from the time-varying parameter autoregressive model (AR(2) Model).


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Published Online: 2018-1-15

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