Inflation Targeting: Insights from Behavioral Economics

• Published in: Eastern European economics Vol. 53; no. 5; pp. 357 - 376
• Main Authors: Brada, Josef C., Kubíček, Jan, Kutan, Ali M., Tomšík, Vladimír
• Format: Journal Article
• Language: English
• Published: Abingdon Routledge 03.09.2015; Taylor & Francis Group, LLC; Taylor & Francis Ltd
• Subjects: Banking; Behavioral economics; Central banks; Economic development; Economic theory; forecast bias; GDP; Gross Domestic Product; Inflation; inflation targeting; Monetary policy; perceived inflation; Studies; Tax revenues; Taxation; Transition economies; Eastern Europe; Czech Republic
• ISSN: 0012-8775; 1557-9298
• DOI: 10.1080/00128775.2015.1089733

In many emerging and transition economies, inflation targeting (IT) has been a successful framework for monetary policy in the areas of improved central bank transparency, higher real GDP growth, and better collection of tax revenues, but has been controversial in other respects. This article reviews the performance of IT in transition economies by focusing on its day-to-day policy conduct from the perspective of behavioral economics. The experience of the Czech National Bank (CNB) is used as a representative example of how IT is implemented in a transition economy. Our review of IT as practiced in the Czech Republic suggests that the CNB's theoretical assumptions may not be fully consistent with the economic behavior of economic agents as described by behavioral economics and therefore lead to biased forecasts. In addition, we find that CNB forecasts are not always turned into policy on the basis of a well-behaved monetary policy reaction function. We discuss the policy implications of our findings.