Monetary, fiscal, financial institutional structures important for inflation targeting

Hove's thesis investigates the role of institutions for inflation targeting policy and the appropriate monetary policy responses to terms of trade shocks in EMEs. "The continued missing of inflation targets by most EMEs which have adopted inflation targeting has raised questions on whether institutional structures really matter for inflation targeting," said Hove.

Role of institutional structures

The thesis contributes to existing literature by taking stock of the intrinsic role played by monetary, fiscal and financial institutional structures in the achievement of inflation targets since the adoption of inflation targeting in EMEs. It also provides a firm framework that is useful for understanding the role of institutional structures in monetary policy.

He found that improvement in institutional structures help in the achievement of inflation targets. "Countries with more independent central banks, strong fiscal institutions and developed financial systems have higher chances of achieving their inflation targets than countries where these institutions are weak. Central banks should therefore continue to reform their institutional structures in order to achieve sustainable price stability."

Hove explained that the heightened volatility of commodity prices in the 2000s coupled with the widespread adoption of inflation targeting in many EMEs has ignited debates about the relative suitability of inflation targeting in dealing with terms of trade shocks compared with other regimes such as monetary targeting and exchange rate targeting.

Appropriate policy for trade shocks

His findings further show that the consumer price index (CPI) inflation targeting regime performs better than monetary targeting and exchange rate targeting regimes in reducing macro-economic volatility in emerging market economies. Inflation targeting is thus the appropriate monetary policy response to terms of trade shocks.

However, inflation targeting regimes stabilise the economies at the expense of higher exchange rate volatility. The CPI-based inflation targeting regime achieves higher welfare than non-traded inflation targeting and exchange rate targeting. "This implies that emerging market economies that are prone to terms of trade shocks should adopt inflation targeting in order to achieve macro-economic stability and enhance welfare," said Hove.