Recalibrating Inflation Targeting Frameworks in Developing Economies: Empirical Evidence from Zambia

Abstract

This study examines the effectiveness of Zambia's inflation targeting (IT) framework from 2015 to 2024 focusing on how deviations from the target range affected policy credibility, macroeconomic stability, and investment inflows. Using quarterly data spanning the decade and employing a Vector Error Correction Model (VECM), the study investigates both the short- and long-term effects of the monetary policy rate (MPR), real GDP, foreign direct investment (FDI), trade flows, and the real effective exchange rate (REER) on the performance of the inflation gap. The findings reveal that Zambia achieved its inflation target in merely 12.5% of the quarters, with substantial deviations occurring in 87.5% of the periods, predominantly during times of fiscal expansion and external shocks. Long-term estimates indicate that increasing the target reduces the inflation gap by 4%, while higher inflation and GDP growth exacerbate it by 12% and 14%, respectively. Additionally, FDI inflows and export growth have contributed to inflationary pressures, compromising price stability and undermining FDI inflows. These results underscore the presence of weak monetary transmission mechanisms and highlight that restoring credibility cannot be accomplished only through monetary tightening. The findings broaden the debate on whether IT frameworks require recalibration in developing and shock-prone economies.  Therefore, the study recommends that, to restore credibility and attract sustainable investment, reforms must go beyond the narrow scope of monetary tightening and adopt a more flexible and adaptive IT strategy appropriate for Zambia and similar developing economies. Developing countries should adopt integrated, flexible, recalibrated macroeconomic strategies that align monetary, fiscal and structural policies for long-term stability.