Inflation plays a prominent role for decisions of economic agents and economic policy makers, notably central banks (CBs). In practically all major economies, monetary policy follows an inflation target (IT) since the mid-1990s. Little attention has been paid, however, in the literature that the central point, inflation, may not only be a result of domestic economic factors but also arises from external factors.

This paper examines the nexus between inflation and the Central Bank’s interest rate policy in inflation targeting countries. First, the paper looks at the role of inflation among other factors for monetary policy. Second, the drivers of inflation alone are examined. Hereby, the role of international spillovers from other countries are explicitly regarded as well, with the aim to assess e.g. to what extent inflation is driven by other countries' inflation or monetary policy is influenced by other economies.

The empirical study covers Organization for Economic Cooperation and Development (OECD) countries and Europe and the Middle East (EMEs) for the period 1995 - 2016, all of which use some form of ITs. We use Bayesian global vector autoregression (GVAR) to model external linkages and to account for variable uncertainty. First, with respect to monetary policy, we find a different commitment to ITs among the official targeters.

Furthermore, we can show that besides inflation, CBs in particularly certain advanced countries, among them the U.S., the EU and the United Kingdom, clearly consider output development in interest setting. Most strikingly, we find that above all in advanced countries CBs consider global developments, notably interest policies of other CBs. Second, we find that inflation is not only determined by domestic factors such as monetary policy, but also by external ones, namely price developments in other countries, oil prices and the exchange rate. Again, the impact of global factors appears predominately in advanced countries.