Is Inflation Targeting a Good Treatment for Enhancing Stock Market Efficiency? A Propensity Score Matching Analysis of Emerging Economies

Following the global financial crisis, the interconnection between financial stability and inflation stability has gained increasing recognition, challenging the notion that these objectives are mutually exclusive. This study empirically examines whether central banks, through the adoption of Full-Fledged Inflation Targeting (FFIT), can enhance stock market efficiency in emerging economies. Utilizing data from 36 emerging markets over the period 1995:Q1 to 2024:Q1, we employ Propensity Score Matching to mitigate self-selection and omitted variable biases. Our findings demonstrate that FFIT significantly improves stock market efficiency, with effects emerging after three quarters and persisting for at least two years, as substantiated by Staggered Difference-in-Differences analysis. These results remain robust across multiple sensitivity tests. Mediation analysis confirms that FFIT enhances efficiency primarily through reduced inflation and interest rate volatility and strengthened institutional credibility. Furthermore, results reveal that IT adoption also enhanced efficiency during the Global Financial Crisis and COVID-19, albeit with a lower amplitude compared to the full-sample analysis. By stabilizing inflation expectations and providing transparent policy guidance, FFIT enables investors to incorporate macroeconomic fundamentals into their decision-making, thereby enhancing market transparency and improving stock market efficiency.