Feasibility study on adopting inflation targeting in Azerbaijan

Abstract

This paper investigates the monetary transmission in Azerbaijan considering need for modernization of the current monetary policy framework. After discussing pre-conditions for successful move to an inflation targeting (IT) regime, the paper examines whether there is efficient monetary transmission mechanism in the economy. Employing vector autoregressive (VAR) approach the paper finds that monetary policy has limited influence on output and inflation as the interest rate channel remains weak. In contrast, the exchange rate channel has greater impact on the inflation rate, as in other transition countries. Azerbaijan can move to IT as soon as the authorities focus solely on inflation and set up a more pronounced transmission mechanism.