Econometric Analysis of the Impact of Inflation Targeting on Macroeconomic Variables: New Keynesian Model

Abstract Many central banks adopted inflation targeting under pressure from the IMF. Adoption of inflation targeting happened on pretty favourable macroeconomic terms whose distinctive features were the absence of supply shocks, low budget deficit and foreign currency access. It was a ‘period conducive to price stability’ with inflation on a downward trajectory in many countries, especially developed ones, even before the introduction of inflation targeting. That could have contributed to efficiency of inflation targeting considering other monetary strategies. The most widely used model in designinig monetary policy under inflation targeting is a macroeconomic model of a small open economy from the group New Keynesian model. The results of the econometric analysis in this paper show that inflation targeting is an inefficient monetary strategy in the face of negative supply shocks (financial crises, pandemic, rising energy prices, tariffs), as it leads to rising interest rates, falling GDP, and rising unemployment. The results of the econometric analysis in this paper show that inflation targeting is an inefficient monetary strategy in the face of negative supply shocks (financial crisis, pandemic, rising energy prices, tariffs, etc.), which leads to rising interest rates, falling GDP, rising unemployment, and ultimately to an “inflationary pandemic”.