Testing the Transparency Benefits of Inflation Targeting: Evidence from Private Sector Forecasts

IMF Working Papers, December 1, 2006

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I test whether inflation targeting (IT) enhances transparency using inflation forecast data for 11 IT adoption countries.
IT adoption promotes convergence in forecast errors, suggesting that it enhances transparency.
The evidence supports Morris and Shin's (2002) contention that better public information is most beneficial for forecasters with bad private information.
The evidence does not support Morris and Shin's hypothesis that better public information could make private forecasts less accurate.

Data: inflation forecast data for 11 IT adoption countries.
Robustness checks:
- The convergence-in-forecast-errors effect is robust to dropping observations.
- Instrumental variable estimation is used to eliminate mean-reversion; using IV estimation strengthens the effect.
- Placebo regressions (where IT adoption is shifted by a year) show the effect is absent, supporting the causal interpretation.

Adoption of inflation targeting is associated with increased transparency as revealed through private sector forecast behavior.
Improved public information under IT appears to particularly aid forecasters who have poor private information, enhancing overall forecast convergence.
There is no empirical support in this analysis for the concern that better public information under IT reduces private forecast accuracy.

Source: IMF Working Papers page for "Testing the Transparency Benefits of Inflation Targeting: Evidence from Private Sector Forecasts".