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Understanding and Predicting Monetary Policy Framework Choice in Developing Countries

Sullivan, Megan (2023): Understanding and Predicting Monetary Policy Framework Choice in Developing Countries.

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We investigate which factors predict choice of monetary policy framework (MPF) among emerging and developing countries. We examine the role that characteristics such as financial market depth and trade networks play in predicting the MPF choice of 87 such countries from 1985-2017. We find that the probability of a medium-sized country picking inflation targeting is approximately 10pp greater than the probability of a large country doing so, after controls are applied. This suggests that large economies do not feel as much of a need to target inflation as smaller ones do. We improve upon previous work on MPF choice by testing the model’s prediction accuracy on unseen data, and addressing endogeneity. We achieve an average prediction accuracy of 68% when using cross-validation methods. This paper enables policymakers to see which MPF countries similar to their own have chosen, and to decide if it is suitable for them, too.

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