Formal adoption of inflation targeting (IT) is neither necessary nor sufficient for attaining low inflation outcomes, a new IMF Working Paper has concluded. 

There is also little evidence that IT adoption improves macroeconomic performance, the Working Paper revealed. This Working Paper—authored by noted economists Surjit S Bhalla, Karan Bhasin and Prakash Loungani—has highlighted that for some countries, IT leads to improved outcomes. However for most countries there is limited impact of a formal targeting framework. This suggests that the experience of IT as being a superior monetary policy framework is not as universal as it is often claimed.

At a time when central banks are struggling to keep inflation in check, the Working Paper results suggest that the belief that IT adoption will be sufficient to achieve this goal cannot be taken for granted. Put simply, IT is a technique used by Central bankers to control the general rise in price level.

The Working Paper examined the impact of formal adoption of IT on inflation, growth and anchoring of inflation expectations in advanced economies and emerging markets and developing economies (EMDEs). 

The early adopters of IT (pre-2000) all saw declines in inflation rates following adoption. However IT adopters since then have enjoyed such success in only about half the cases, the Paper revealed. IT adoption delivers significant inflation gains in about a third of the cases. At the same time, the authors also found limited support for the concern that adoption of IT systematically leads to poorer growth outcomes. 

This Working Paper titled ‘Macro-effects of formal adoption of Inflation Targeting’ comes at a time when it is has become commonplace for central bankers and international financial institutions (IFIs) to assert the benefits of the adoption on inflation targeting.  

While not denying these claims, the authors, however, noted that Central bankers and IFIs would do well to look at the evidence on IT with a more “critical eye, given the dangers of groupthink at these institutions as highlighted in some quarters”.

For this study, the authors looked into inflation performance of a total of 190 countries, of which 24 were classified as advanced economies (AEs) and the remainder as emerging markets and developing economies (EMDEs). They used annual data on inflation and GDP compiled by the World Bank and the IMF’s International Financial Statistics. 

The Working Paper found that though early IT-adopters ( pre 2000) saw inflation declines post adoption, only half of the 22 subsequent adopters saw post-adoption inflation declines.

There is no difference between IT-adopters and other countries in the average level and volatility of inflation. Likewise, there is no difference in expected inflation and no difference in the anchoring of inflation between the two groups, the Working Paper concluded. “Regression to the mean continues to offer a plausible explanation for the assumed benefits of IT adoption, and we have shown that it holds for EMDEs just as well as for advanced economies”, it added. 

A comprehensive country-level analysis comparing inflation and growth outcomes in IT adopters with a counterfactual turns up little evidence that IT adoption improves macroeconomic performance, according to their findings.

The Working Paper has suggested that the focus of central banks and IFIs ought to be on why some countries had better outcomes than others, and what could be learned from their experience that would be useful to other countries.

Noting that the results of their study do not provide a full cost-benefit analysis of inflation targeting, the authors have said there are several possible advantages to IT that have not been considered here. “At the same time, adherence to IT can also lead to policy mistakes if policymakers become too focused on attaining the inflation objective to the detriment of other objectives”.

Alternative explanations

The authors have made a case for serious consideration of the alternative explanations for the great moderation in inflation. The main alternative explanation is that various structural factors, such as demographic changes and globalisation have played a key role in moderation of inflation over the last few decades, the authors noted.

The Working Paper noted that the decline in inflation over the last three decades coincided with the formal adoption of inflation targeting. This makes it challenging to estimate the causal impact of the adoption of inflation targeting on inflation. In addition, theoretically, formal adoption of inflation targeting reduces inflation by ‘anchoring expectations’ and enhanced credibility of the central bank. The same, could, in theory be achieved through a persistent period of low inflation as experienced.


India had introduced inflation targeting framework in 2016. Post this move, the concept of Monetary Policy Committee (MPC) was introduced to set the policy rates in the country. 

The inflation target given to MPC for 2021-26 is 4 per cent with 2 percentage points on either side, leading it to a tolerance band of 2-6 percent. This tolerance band is the same as the one given for the previous five years beginning 2016. 

RBI had in 2022 for the first time failed to meet the contracted inflation target, triggering a letter from the central bank to the government enumerating the reasons for the miss and also when it sees the price rise coming to the 4 per cent mark.

India’s average inflation in three years prior to 2016 was 7.7 percent, while the average was 5 percent in the next three years.