Impact of Inflation Targeting on External Debt: Evidence from Low-Income Countries

Abstract

Abstract Research background This study explores the impact of inflation targeting on external debt in low-income countries, filling a gap in understanding its effects on debt management in these countries. Purpose Our research aims to determine whether the adoption of inflation targeting can lead to a reduction in external debt for low-income countries, using a robust methodology that accounts for selection bias. Research methodology We use propensity score matching (PSM) to analyse data from 37 low-income countries between 1990 and 2020. Of these countries, 19 have adopted inflation targeting, while 18 have not, enabling a balanced comparison of the two groups. Results Our results indicate that inflation targeting leads to a significant reduction in external debt of 14.561% on average. This substantial reduction is attributed to enhanced monetary credibility and a reduced risk of default on public debt. Novelty This study enriches the literature by providing robust empirical evidence on the beneficial effects of inflation targeting in low-income countries. The study highlights its potential as a debt management tool and emphasises the importance of adapting economic policies to the specific context of each country.