Behavioural perspective of the inflation targeting strategy: The case of Serbia

Abstract

Regarding inflation, the lion's share of theory and literature refers to the analysis of its economic determinants. In our empirical analysis, we emphasized some behavioural factors embodied in the short-term inflation expectations of banks and companies, which are regarded as one of the essential factors for reaching desired current inflation dynamics. We considered whether and how the Central Bank can, through inflation targeting as monetary strategy, nudge the inflation expectations of market participants in the preferred direction. In the paper, we looked into the performances of inflation targeting in the case of Serbia and considered potential explanations of the given (un)success from both a neoclassical and a behavioural theoretical perspective. We found that in the case of Serbia market participants' expectations in one year ahead strongly influences the actual year-on-year inflation rate. Obviously less influence on actual inflation that comes from inflation expectations of the real economic sector in comparison to the financial sector could be attributed to both economic and psychological phenomenon of downward price rigidity in the internal environment of companies, which adjust with a delay to changes in market prices. The success of inflation targeting soundly depends on the way the Central Bank manages the formation and influences the movements of inflation expectations of market participants, especially banks which could be seen as professional forecasters.