Assessing Central Bank Commitment to Inflation Targeting: Evidence from Financial Market Expectations in India
Gauging the success of a central bank’s inflation targeting regime by testing the degree to which inflation expectations become anchored can be problematic because exogenous macroeconomic shocks will also affect expectations. In addition, if the study examines an emerging-market economy, data on long-term inflation expectations will be lacking, making it difficult to assess the extent to which expectations have become anchored. Instead of focusing on realized inflation expectations in isolation, this paper combines a variety of survey forecasts with high-frequency financial market data to study how economic agents change their beliefs about the central bank’s response function after the adoption of inflation targeting. The paper applies this methodology to study India, a large emerging-market economy whose central bank, the Reserve Bank of India, adopted flexible inflation targeting in 2015.