Inflation Targeters Do Not Care (Enough) About Financial Stability: a Myth? Investigation on a Sample of Emerging Market Economies

The 2008/2009 financial crisis raises issues related to the monetary policy doctrine of the last two decades. Inflation targeting monetary strategy has been criticized as a source of the crisis, as its main objective of inflation stabilisation might have diverted central banks from other concerns such as financial stability. As a first attempt in the literature for emerging countries, this study aims at investigating (i) whether inflation targeting central banks are actually less responsive to financial imbalances relative to non-targeters, and (ii) whether financial sector in inflation targeting countries is more fragile as compare to their peers. First, we build a composite index in order to get a more complete and comprehensive view of financial conditions in emerging countries. Second, using Taylor-type rule, we estimate the central banks reaction to financial imbalances. And third, we estimate the effect of adopting inflation targeting on financial stability. Our findings suggest that inflation targeting central banks are more responsive to financial imbalances in their interest rate setting. However, the financial sector seems to be more unstable in inflation targeting countries as compare to others. These findings suggest that, even if inflation targeting might be associated to higher financial fragility, this can hardly be attributed to the central banks ‘carelessness ’ about developments in the financial sector. For emerging market economies, especially those implementing inflatio