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Inflation and Growth
Inflation Targeting in Non-Industrial Countries
Table of Contents of IMF Staff Papers (September/December 1999)
IMF Occasional Papers
Conference on capital Flow and Debt Statistics:
Can We Get Better Data Faster?
Seminar: Agenda for Sequencing Decentralization in Indonesia
Conference on Implementing Inflation Targeting
Conference on International Financial Contagion:
How It Spreads, How It Can Be Stopped
External Publications of IMF Staff in 1999
Other External Publications: Including Books, Conference Volumes
Visiting Scholars at the IMF, January–March 2000
Work in Progress
Inflation and Growth
Atish R. Ghosh
Rapid output growth and low inflation are among the most important objectives of macroeconomic policy. But are they complements? Or are there trade-offs between lowering inflation and achieving high growth? This question, central to the IMF's program and surveillance activities, has long been an area of active research within the Fund, with more than two dozen research papers written on the subject in the past five years alone.
The focus of this literature is more the long-run growth and inflation performance of countries than the short-run Phillips curve considerations (though there has been a fair amount of research at the Fund on the latter as well),1 and part of the impetus for this literature was the experience of the transition economies. It did not take researchers long to notice that the transition economies that achieved low inflation were also the ones that achieved the fastest turn around in output growth.2 Beyond the transition economies, two papers (not written at the Fund) were particularly influential. Fischer (1993) showed that high inflation (presumably reflecting the distortive effects of relative price uncertainty) was associated with lower GDP growth, while Bruno and Easterly (1998) argued that "[while] the case for a negative association of inflation and growth is firmly established when we look at the temporal association of growth with discrete high inflation crises... the case for growth effects of low to moderate rates of inflation remain very much ambiguous."3
Much of the research on inflation and growth at the Fund has thus tried to answer three key questions: (i) is there a robust negative relationship between inflation and growth? (ii) is there a "kink" in the relationship so that, at very low levels of inflation, the relationship is positive (perhaps due to Phillips curve effects)? (iii) does inflation have to reach some minimum "threshold" before the growth effects become serious?
Sarel (1996), in a panel study, argued that there was indeed a (very) low inflation "kink" in the relationship (at around 8 percent), below which the relationship switches signs (inflation and growth are positively correlated). Neither Sarel (1996) nor a subsequent paper by Ghosh and Phillips (1998), however, found any evidence of a "threshold effect."4 In fact, beyond the low inflation "kink," the negative relationship is rather smooth and convex –actually well approximated by a logarithmic function so that the greatest marginal loss in growth occurs at low inflation rates. A linear model, in which a 1 percentage point increase in the rate of inflation has the same effect irrespective of whether the initial inflation rate is 10 percent or 100 percent per year seems implausible. A logarithmic model, in contrast, implies that doubling the initial inflation rate has the same effect.
The results suggest that the inflation-growth relationship is less like falling off a precipice than like going down a playground slide (the old-fashioned kind, with a ladder at the back, and a metal slide in the front). Let the vertical height represent GDP growth, and the horizontal distance traveled represent the inflation rate. Assuming the ladder is slightly sloped forward, in the first few inches (initial low inflation) height rises (GDP growth increases). The top of the ladder (and the beginning of the slide) represents the "kink" point. Beyond that, height is lost rapidly at the start of the slide (GDP growth falls quickly with increasing inflation); by the end of the slide, the marginal loss in height is small, but the total height off the ground is also low. (The slide analogy is sadly apt: many countries find it easy to slip into high inflation and low growth; climbing back up is rather more difficult.)
These basic results have been confirmed in a large number of panel, cross-section, and individual country studies undertaken at the Fund.5 The magnitude of the effect differs across samples and studies, but it is roughly on the order of ½ percentage point of (per capita) growth for each doubling of the inflation rate (beyond the "kink"). Of course, these papers are careful not to make claims of causality, but it is interesting to note that the statistical relationship between inflation and growth remains even after controlling for the usual suspects--fiscal performance, wars, droughts, population growth, openness, and even human and physical capital--and allowing for simultaneity bias. More generally, attaining low inflation may be part of a package of reforms, and a few papers have tried to look at interactions and policy complementarities explicitly.6
Much of the more recent and current research on this topic tries to pin down more precisely the location of the "low" inflation kink, and whether the estimated effects of inflation on growth depend, inter alia, on the stage of economic development, the degree of capital mobility, the structure of the economy, or the exchange rate regime (the sacrifice ratio under money versus exchange rate based stabilizations is a literature unto itself, and is not surveyed here).7
As countries move down the inflation scale, and reap the growth bonus, these issues will gain even greater importance--and will surely continue to be active areas of research at the Fund.
The adoption of inflation targeting (IT) as a framework for monetary policy by a number of industrial countries in the early 1990s made IT one of the most widely researched topics in the field of monetary economics during the last decade.1 By the mid 1990s, questions about the applicability of this policy framework to non-industrial countries started to gather momentum. Unlike in the case of industrial countries, where IMF work on IT developed in parallel with a large body of outside literature, the Fund quickly became a major contributor to this area of research. In fact, in the last four years IMF staff have produced more than twenty research papers on the broad theme of the applicability of IT to non-industrial countries, including some theoretical contributions motivated, at least partly, by the interest in expanding IT beyond the realm of industrial economies.
The early stage of this research program was mainly exploratory. Studies at this stage were generally concerned with identifying the prerequisites for the adoption of IT, clarifying the basic components of the framework, assessing (formally, in some cases) the degree of compliance with those prerequisites and components, and gauging the benefits of using inflation targets as the main anchor for monetary policy in non-industrial countries. The majority of studies focused on specific regions or countries, mostly from Central and Eastern Europe and South East Asia.2 The two exceptions were the studies by Masson, Savastano and Sharma (1997) and Eichengreen, Masson, Savastano and Sharma (1999), which examined the issue of the applicability of IT to developing countries in general--though the latter piece placed the question in a somewhat more restricted context.3
As a number of emerging market countries actually started to adopt IT as a monetary policy framework, or accelerated their "transitioning" towards that framework, the Fund research in this area moved to a second stage, and began to focus on specific aspects of the implementation and operation of IT in those economies. Thus, for example, De Fiore (1998) examined econometrically the relative importance of different transmission channels of monetary policy in Israel under IT; Clifton (1999) also analyzed the experience of Israel to illustrate the possible drawbacks of relying on target bands to anchor inflation expectations; Leone (1999) documented the rapid implementation of IT in Brazil following the currency crisis of early 1999; Mishkin and Savastano (2000) illustrated the uneven transition towards IT in Chile, Colombia, Mexico, Peru and Brazil during the 1990s; and Corker, Beaumont, van Elkan and Iakova (2000) discussed the modifications to the IT framework that the Czech Republic and Poland may need to consider as they approach the date of accession to the European Union.4 The experience with IT of most of these emerging economies is comprehensively summarized in a forthcoming study by Schaechter, Stone and Zelmer (2000) which, in addition, highlights the commonalities and differences of the IT frameworks adopted by those economies compared to those of industrial countries.5
The Fund's contribution to the theoretical literature on IT was pioneered by Green (1996) who showed, in a modified Barro-Gordon setting, that announcing inflation targets was not sufficient to eliminate the "inflation bias" from monetary policy and, hence, to bolster credibility, unless the central bank also announced output targets that were consistent with the targets on inflation.6 Of the ensuing theoretical work on this topic at the IMF the studies of Beddies (1999) and Jadresic (1999) shed light on aspects of IT of particular importance for emerging economies.7 Using completely different models, both of which stress features that are prominent in developing countries--the reliance on seigniorage and the presence of "sticky-prices," respectively--these studies show that (strict) inflation targeting will generally be associated with "excessive" output instability, and that this result may or may not disappear under alternative specifications of the problem.
The growing interest on IT in emerging market economies, and the various modifications and adaptations that the framework is likely to undergo as it becomes adopted, and tested, in a larger sample of (developing) countries makes this a very fertile area for future research, both inside and outside the Fund.
Determinants and Leading Indicators of Banking Crises:
Time Series Analysis of Export Demand Equations:
A Cross-Country Analysis
The Uzbek Growth Puzzle
Monetary Policy and Public Finances: Inflation
Targets in a New Perspective
Exchange Rate Fluctuations and Trade Flows:
Evidence from the European Union
IMF Staff Papers, the IMF's scholarly journal, edited by Robert Flood, publishes selected high-quality research produced by IMF staff and invited guests on a variety of topics of interest to a broad audience including academics and policymakers in the member countries of the IMF. The papers selected for publication in the journal are subject to a rigorous review process using both internal and external referees. The journal and its contents (including an archive of articles from past issues) are available online at http://www.imf.org/external/pubs/ft/staffp/index.htm.
IMF Occasional Paper No. 186
IMF Occasional Paper No. 187
IMF Occasional Paper No. 188
IMF Occasional Paper No. 189
IMF Occasional Paper No. 190
IMF Occasional Paper No. 191
The External Wealth of Nations: Measures
of Foreign Assets and Liabilities for Industrial and Developing Countries
The aim of this dataset is to provide a comprehensive set of estimates of the international investment positions of 66 countries for the period 1970–1997, using primarily balance of payments data on capital flows. The estimates are based on existing stock measures, when available, supplemented by the cumulation of capital flows, with appropriate valuation adjustments. Gross international investment position data are available for several industrial countries, typically starting in the 1980s For those countries, the dataset provides a longer time series for assets and liabilities, based on (adjusted) cumulative flow data. For developing countries, the contribution of the dataset is more substantial because stock data are generally available only for gross external debt and foreign exchange reserves (data on international investment positions are available for only a few countries and a very limited number of years). An additional contribution consists in adjusting the estimated stock measures for equity and foreign direct investment so as to reflect, albeit crudely, the effect of changes in market prices and exchange rates.
The data would be of interest to applied international economists working on international capital flows. The working paper describing the data and methodology (IMF Working Paper 99/115, August 1999), along with the dataset and the documentation, are publicly available through the Research at the IMF website: http://www.imf.org/research.
This conference, sponsored by the Statistics Department and the Policy and Development Review Department, in Cooperation with the Financial Stability Forum Working Group on Capital Flows, took place in Washington, DC on February 23–24, 2000.
The focus of the conference was on what actions and resources would be required to provide better and more timely data on capital flows and debt and what specific initiatives should be given priority. Approximately 120 senior-level data users, policymakers, and data compilers participated in the conference, which was intended to generate a dialogue between data users and compilers, discuss recent initiatives to improve data on capital flow and debt statistics, and identify priorities for further work in this area.
Proceedings of IMF conferences and seminars, including agenda and papers, can be obtained though the "Conferences, Seminars and Workshops" link at theResearch at the IMFwebsite: http://www.imf.org/research.
This seminar on Indonesian decentralization and its management, sponsored by the World Bank and the Fiscal Affairs Department of the IMF, was held in Jakarta, Indonesia on March 20–21, 2000. The seminar was intended to provide the opportunity for an exchange of views on the next steps for decentralization in Indonesia, given the country's political realities, as well as the experiences of other countries. The forum included officials from various central government agencies, as well as representatives of regional governments, academics, international scholars, and participants with experience in decentralization processes in other countries around the world.
Proceedings of IMF conferences and seminars, including agenda and papers, can be obtained though the "Conferences, Seminars and Workshops" link at the Research at the IMF website: http://www.imf.org/research.
A high-level seminar organized by the IMF Institute on March 20–21, 2000 brought together top academics and policymakers to discuss issues related to the implementation of inflation targeting. A brief summary of the conference follows.
Leading off, Stanley Fischer put inflation targeting into a broader macroeconomic context. Inflation targeting may be a means to attain the ultimate goal of macroeconomic policy, namely high and stable growth. Fischer noted several examples of inflation targeting, as well as potential cases where inflation targeting might be well suited.
Relating inflation targeting to the older rules-versus-discretion debate in macroeconomics, Bennett McCallum proposed backward-looking rules to target either a monetary aggregates or an interest rate. His counterfactual estimates suggest that if policy makers in several industrial economies adhered to such a rule, inflation would have been substantially reduced over the past three decades. He preferred targeting monetary aggregates (specifically, base money) to interest rates since the former is simpler.
Vincent Reinhart noted that, to maximize consumer welfare, policy makers should follow a forward-looking interest rate rule. Such a rule is somewhat closer to inflation targeting as currently practiced. Lars Svensson emphasized that inflation targeting regimes helped policy makers focus on one goal, but not exclusively so. He noted that it would be very difficult to eliminate the discretionary element from policy, but that inflation targeting placed constraints on otherwise unconstrained discretion. He also discussed the inherent tradeoff between price and output variability.
Michael Mussa discussed, inter alia, the most appropriate measure of inflation to be targeted. While omitting supply shocks to petroleum and food might theoretically be desirable, the public might have difficulty understanding the "cold and hungry CPI." Timothy Lane discussed inflation targeting in the context of IMF programs. Care must be taken, he emphasized, to assure that inflation goals are consistent with other program targets like net domestic assets or net international reserves.
Next, policy makers from several countries discussed the actual implementation of inflation targeting. Charles Freedman discussed the Canadian experience that started in 1991. After attempts to restrain inflation by targeting monetary aggregates repeatedly failed, the Bank of Canada shifted to inflation targeting. With limited success, exchange rate movements were also included in a monetary conditions index. Considerable emphasis was placed on both inflation forecasting and transparency.
David Archer noted that in New Zealand, consumer price inflation, purged of interest payments, is recognized as the only target and little attention is paid to intermediate indicators. The central bank aims for clear and transparent communication with the public. Any country faces a tradeoff between output variability and price variability. Archer's research suggested that output variability is minimized at relatively low rates of inflation and that inflation targeting had not boosted output variability in New Zealand. Andrew Haldane stressed the proactive nature of inflation targeting in the UK. Often, indications of future inflation are "ghosts", not visible to the naked eye, and central bankers are cast in the role of "ghostbusters". Owing to the long and variable lags in monetary policy, the Bank of England devotes considerable resources to inflation forecasting.
Leonardo Leiderman suggested that when inflation targeting was adopted in Israel, monetary policy discussions at the central bank became substantially more focussed. Historically, inflation had been high and the central bank lacked credibility. Thus, a key element of inflation targeting, especially in light of recent budgetary imbalances, would be a supportive fiscal policy. Alejandro Werner (in a paper co-authored with Agustín Carstens) noted that Mexico has been gradually moving toward an inflation-targeting regime. In recent years, as inflation has fallen, Mexico has published targets for both monetary aggregate and inflation. Sergio Werlang discussed how inflation targeting emerged from the devaluation of the Real in early 1999. As the country moved toward a more flexible exchange rate and important fiscal adjustments were made, Brazilian policy became more transparent and understandable for the public.
Leonardo Leiderman and Eduardo Aninat
provided some summary remarks.
Proceedings of IMF conferences and seminars, including agenda and papers, can be obtained though the "Conferences, Seminars and Workshops" link at the Research at the IMF website: http://www.imf.org/ research.
This conference, sponsored jointly by the World Bank, the Asian Development Bank and the IMF, was held in Washington, DC on February 3–4, 2000. A listing of papers presented at the conference follows. The papers can be obtained at the website noted below.
The Center and the Periphery: Tales of Financial Turmoil
The Channels for Financial Contagion
Contagion: How It Spreads and How It Can
Contagion of International Financial Crises:
The Case of Mexico
Crisis Transmission: Evidence from the Debt,
Tequila and Asian Flu Crises
Economic Fragility, Liquidity, and Risk:
The Behavior of Mutual Funds during Crisis
Financial Contagion in the East Asian Crisis-With
Special Reference to the Republic of Korea
Financial Contagion: Spillovers through Banking
Financial Market Spillovers in Transition
Flight to Quality
International Contagion: Implications for
The International Transmission of Financial
Crises before World War II: Was there Contagion?
Lending in Emerging Markets: Foreign and Domestic
Looking for Contagion: Evidence from the 1992
Managers, Investors and Crises: Mutual Fund
Strategies in Emerging Markets
Measuring Contagion: Conceptual and
Portfolio Diversification, Leverage and Financial
The Portfolio Flows of International Investors
The Russian Default and the Contagion to Brazil
Thai Meltdown and Transmission of Recession
with Asian4 and NIE4
Proceedings of IMF conferences and seminars,
including agenda and papers, can be obtained though the "Conferences, Seminars
and Workshops" link at the Research at the IMF website: http://www.imf.org/
Agénor, Pierre-Richard; Bismut, Claude; Cashin,
Paul; McDermott, C. John
Agénor, Pierre-Richard; Masson, Paul
Aitken, Brian; Harrison, Ann
Bakker, Bas; Hilbers, Paul; Martijn, Jan Kees
Baland, Jean-Marie; Dreze, Jean; Leruth, Luc
Barnett, Steven A.; Sakellaris, Plutarchos
Bartolini, Leonardo; Prati, Alessandro
Bayoumi, Tamim; Coe, David; Helpman, Elhanan
Blejer, Mario; Schumacher, L.
Bogetic, Zeljko; Petrovic, Pavle; Vujosevic,
Carneiro, F. G.; de Mello, Luiz
Clark, Peter B.; Goodhart, Charles A. E.; Huang,
Clements, Benedict; Schwartz, Gerd
Cordella, Tito; Foucault, T.
Corneo, G.; Jeanne, Olivier
Corneo, G.; Jeanne, Olivier
Corneo, G.; Jeanne, Olivier
Davoodi, Hamid; Xie, Danyang; Zou, Heng-fu
de Mello, Luiz
de Mello, Luiz
de Mello, Luiz; Hussein, K.
de Palma, Andre; Leruth, Luc; Régibeau,
Dell'Ariccia, Giovanni; Friedman, Ezra; Marquez,
Detragiache, Enrica; Hamann, A. J.
Duggan, James E.; Gillingham, Robert
Garfinkel, Michelle; Glazer, Amihai; Lee, Jaewoo
Hanson, Gordon; Spilimbergo, Antonio
Henstridge, Mark N.
Hindriks, J.; Keen, Michael; Muthoo, A.
Kotlikoff, Laurence J.; Smetters, Kent A.; Walliser,
Krishna, Kala; Tan, Ling Hui
Ligthart, Jenny; van der Ploeg, F.
Rother, Philipp C.
Spilimbergo, Antonio; Londoño, Juan
Luis; Székely, Miguel
Van Rijckeghem, Caroline
Al-Atrash, Hassan; Havrylyshyn, Oleh
Auerbach, Alan J.; Braz, Jose; Kotlikoff,
Laurence J.; Macedo, Jorge De; Walliser, Jan
Blejer, Mario; Skreb, Marko (editors)
Blejer, Mario; Skreb, Marko (editors)
Blejer, Mario; Skreb, Marko (editors)
Bogetic, Zeljko; Hanke, Steve H.
Clark, Peter; MacDonald, Ronald
Cordella, Tito; Minelli, E.; Polemarchakis,
de Mello, Luiz
de Mello, Luiz; Fukasaku, K.
Demirgüç-Kunt, A.; Detragiache,
Edison, Hali; Fernald, John; Loungani, Prakash
Eichengreen, Barry; Masson, Paul; Savastano,
Miguel; Sharma, Sunil
Eliasson, Ann-Charlotte; Isard, Peter; Laxton,
Hamid, Faruqee; Isard, Peter; Masson, Paul
Haque, N. U.; Pesaran, M. H.; Sharma, Sunil
Havrylyshyn, Oleh; Izvorski, Ivailo; Rooden,
Huang, Haizhou; Xu, Chenggang
Huang, Haizhou; Xu, Chenggang
Izquierdo, Mario; Ley, Eduardo; Ruiz-Castillo,
Kochhar, Kalpana; Loungani, Prakash; Stone,
Loungani, Prakash; Shaghil, Ahmed
McCarthy, Margaret; Wang, Qing; Weiling, Jeffrey
Milesi-Ferretti, Gian Maria; Razin, Assaf
Prati, Alessandro; Schinasi, Garry
Raffelhüschen, Bernd; Walliser, Jan
Tanzi, Vito; Zee, Howell
Van Rijckeghem, Caroline
A Full and updated listing of external publications of IMF staff (from 1997 onwards), including
forthcoming publications, can be found in a searchable database at Research at the IMF
Barr, Nicholas; London School of Economics,
The IMF is primarily a policy institution. As a basis for its policy work, however, a significant amount of background research and analytical work is done in various departments at the IMF. Much of this research is original work while some of it is synthetic and draws mainly on work done outside the institution.
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