How are Inflation Targets Set?

This paper contributes to a better understanding of how inflation targets are set. First, we gather evidence on how inflation targets are set from official central bank and government publications and from a questionnaire of our own design. Second, we estimate the determinants of the level of the inflation target in 19 inflation-targeting countries using unbalanced panel interval regressions to deal with the issue that targets are typically set as a range rather than as a point. We find that both a higher level and higher variability of inflation are associated with a higher target. The setting of the inflation target is also found to have an important international dimension, because higher world inflation is positively correlated with inflation targets. Rapidly growing countries exhibit higher inflation targets. Our results also show that authorities establish a wider target range for the inflation rate when the macroeconomic environment is less stable. We find that central bank credibility is negatively associated with the level of the inflation target, suggesting that less credible central banks are likely to recognize the risks related to anchoring inflation expectations at low levels. On the other hand, government party orientation does not matter, even in less independent central banks.Central bank, credibility, independence, inflation, inflation targeting.

Do Financial Variables Help Predict Macroeconomic Environment? The Case of the Czech Republic

In this paper, we 1) examine the interactions of financial variables and the macroeconomy within the block-restriction vector autoregression model and 2) evaluate to what extent the financial variables improve the forecasts of GDP growth and inflation. For this reason, various financial variables are examined, including those unexplored in previous literature, such as the share of liquid assets in the banking industry and the loan loss provision rate. Our results suggest that financial variables have a systematic and statistically significant effect on macroeconomic fluctuations. In terms of forecast evaluation, financial variables in general seem to improve the forecast of macroeconomic variables, but the predictive performance of individual financial variables varies over time, in particular during the 2008–2009 crisis.Forecasting, macroeconomic and financial linkages, vector autoregressions.

Early Warning Indicators of Economic Crises: Evidence from a Panel of 40 Developed Countries

Using a panel of 40 EU and OECD countries for the period 1970-2010 we construct an early warning system. The system consists of a discrete and a continuous model. In the discrete model, we collect an extensive database of various types of economic crises called CDEC 40-40 and examine potential leading indicators. In the continuous model, we construct an index of real crisis incidence as the response variable. We determine the optimal lead employing panel vector autoregression for each potential indicator, and then select useful indicators employing Bayesian model averaging. We re-estimate the resulting specification by system GMM and, to allow for country heterogeneity, additionally evaluate the random coefficients estimator and divide countries into clusters. Our results suggest that global variables are among the most useful early warning indicators. In addition, housing prices emerge consistently as an important source of risk. Finally, we simulate the past effectiveness of several policy instruments and conclude that some central bank tools (for example, reserves) could be useful in mitigating crisis incidence.Bayesian model averaging, dynamic panel, early warning indicators, macroprudential policies, panel VAR.

Comparing different early warning systems: Results from a horse race competition among members of the Macro-prudential Research Network

Over the recent decades researchers in academia and central banks have developed early warning systems (EWS) designed to warn policy makers of potential future economic and financial crises. These EWS are based on diverse approaches and empirical models. In this paper we compare the performance of nine distinct models for predicting banking crises resulting from the work of the Macroprudential Research Network (MaRs) initiated by the European System of Central Banks. In order to ensure comparability, all models use the same database of crises created by MaRs and comparable sets of potential early warning indicators. We evaluate the models’ relative usefulness by comparing the ratios of false alarms and missed crises and discuss implications for pratical use and future research. We find that multivariate models, in their many appearances, have great potential added value over simple signalling models. One of the main policy recommendations coming from this exercise is that policy makers can benefit from taking a broad methodological approach when they develop models to set macro-prudential instruments

Comparing different early warning systems: Results from a horse race competition among members of the Macro-prudential Research Network

Over the recent decades researchers in academia and central banks have developed early warning systems (EWS) designed to warn policy makers of potential future economic and financial crises. These EWS are based on diverse approaches and empirical models. In this paper we compare the performance of nine distinct models for predicting banking crises resulting from the work of the Macroprudential Research Network (MaRs) initiated by the European System of Central Banks. In order to ensure comparability, all models use the same database of crises created by MaRs and comparable sets of potential early warning indicators. We evaluate the models’ relative usefulness by comparing the ratios of false alarms and missed crises and discuss implications for pratical use and future research. We find that multivariate models, in their many appearances, have great potential added value over simple signalling models. One of the main policy recommendations coming from this exercise is that policy makers can benefit from taking a broad methodological approach when they develop models to set macro-prudential instruments

Comparing different early warning systems: Results from a horse race competition among members of the Macro-prudential Research Network

Over the recent decades researchers in academia and central banks have developed early warning systems (EWS) designed to warn policy makers of potential future economic and financial crises. These EWS are based on diverse approaches and empirical models. In this paper we compare the performance of nine distinct models for predicting banking crises resulting from the work of the Macroprudential Research Network (MaRs) initiated by the European System of Central Banks. In order to ensure comparability, all models use the same database of crises created by MaRs and comparable sets of potential early warning indicators. We evaluate the models’ relative usefulness by comparing the ratios of false alarms and missed crises and discuss implications for pratical use and future research. We find that multivariate models, in their many appearances, have great potential added value over simple signalling models. One of the main policy recommendations coming from this exercise is that policy makers can benefit from taking a broad methodological approach when they develop models to set macro-prudential instruments

How Are Inflation Targets Set?

This paper aims to contribute to a better understanding on how inflation targets are set. For this reason, we first gather evidence from official central bank and government publications and from a questionnaire sent to central banks on how inflation targets are set; we then estimate the determinants of the level of inflation target in 19 inflation targeting countries using unbalanced panel interval regressions (to deal with the issue that targets are typically set as a range rather than as a point). Inflation targets are found to reflect macroeconomic fundamentals. Higher level as well as higher variability of inflation are associated with higher target. The setting of the inflation target is also found to have an important international dimension, as higher world inflation is positively correlated with inflation targets. Rapidly growing countries exhibit higher inflation targets. Our results also suggest that the larger width of inflation target is set in a more volatile macroeconomic environment. We find that central bank credibility is negatively associated with the level of inflation target, suggesting that less credible central banks are likely to recognize the risks related to anchoring inflation expectations at low levels. On the other hand, government party orientation does not matter even in less independent central banks.inflation targeting; central bank; inflation; credibility; independence;