Effect of Inflation Targeting on Inflation Uncertainty: A SWARCH Analysis

Abstract

We analyse the success of inflation targeting (IT) in decreasing inflation volatility by investigating inflation variance before and after IT. We contribute to the literature by implementing Markov?Switching AutoRegressive Conditional Heteroscedastic methodology to model inflation volatility. After determining the unbiased conditional variances of inflation in each inflation?targeting country, we investigate structural breaks in inflation variability by both analysing individual countries and conducting a panel data analysis. All of these methods conclude that IT helps most of the countries to achieve lower inflation uncertainty (volatility). We also examine the country?specific factors that determine the effectiveness of inflation?targeting adoption.