Academic journal article Journal of Economic Development

Does Inflation Targeting Matter for Foreign Portfolio Investment: Evidence from Propensity Score Matching

Academic journal article Journal of Economic Development

Does Inflation Targeting Matter for Foreign Portfolio Investment: Evidence from Propensity Score Matching

Article excerpt

(ProQuest: ... denotes formulae omitted.)


Since the early 1990s, IT regime has been adopted by several central banks as a new monetary policy strategy. Over the years, this monetary policy strategy has become very popular, and many arguments have been forwarded for this trend. Economists and policymakers highlighted the need for central banks to show more discretion and liberty in handling their instruments, along with improving their credibility. They also emphasize that IT does not preclude central banks from having multiple goals for monetary policy. An IT regime can accommodate a goal of output stabilization by having wide inflation target bands, long inflation target horizons, and explicit exemptions for supply shocks (Rudebush and Walsh, 2001a, 2001b; Ersel and Özatay, 2008). Thus, IT could be suitable for emerging market countries (EMCs) as it helps them to not focus exclusively on inflation goals over the short-term, which could lead to a highly unstable real economy.

A growing body of literature has brought attention to IT regime performance. Although much of the existing literature on the record of IT has focused on whether inflation and its volatility have been reduced (Meyer, 2001; Neumann and VonHagen, 2002; Lin and Ye, 2007, 2009; De Mendonça and Souza, 2012), and whether other objectives, in particular the volatility of output have been compromised (Mishkin and Posen, 1997; Ball and Sheridan, 2003; Mishkin, 2004; Walsh, 2009; Brito and Bystedt, 2010), a new strand of empirical literature has recently attempted to appraise the effect of IT on other variables. Epstein (2007) suggested shedding light on the relationship between IT and FDI. Indeed, such linkages seem understudied so far. A study like the one of Tapsoba (2012) is an exception. For instance, the latter author finds that IT contributes to attract and enhance foreign direct investment (FDI) inflows into developing countries.

Another body of empirical literature seems to discredit the previous findings regarding the positive effects of IT on economic performances. For instance, Brito and Bystedt (2010) conclude that there is no clear-cut evidence that IT improves economic performance in developing countries when making use of a dynamic panel estimator. Likewise, Ball and Sheridan (2003) find that on average, there is no evidence that IT improves performance and that better performance results from something other than IT regime when applying standard differences in differences approach.

By and large, many methods were used to find out the effect of the adoption of IT on several key economic variables. Lin and Ye (2007, 2009), De Mendonça and Souza (2012) use a variety of propensity score matching (PSM, hereafter) methodology to reveal the effect of the adoption of IT regime on inflation and its volatility. They find out that the average treatment effects of IT on inflation and its volatility are statistically insignificant in industrial countries and statistically significant in developing countries. Brito and Bystedt (2010) apply a dynamic panel estimator on a sample of 46 developing countries; they show that the control of common time effects causes a lower significant effect of IT on inflation and its volatility. Ball and Sheridan (2003) use standard differences in differences approach and they argue that when there is a control for regression to the mean, IT does not have a significant effect on the performance of the country, and the economic outcome does not change.

Against this background, this paper aims at making a contribution to the ongoing debate by investigating whether IT implementation in EMCs boosted FPI inflows and contained FPI volatility or not. To this purpose, this paper uses the best-fitted methodology, namely the PSM methodology. Its main advantage is that it deals with the self-selection problem as compared to other methods. The sample used contains 38 emerging countries, where 13 countries have adopted IT regime and 25 have not adopted IT regime over the period 1986-2010. …

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