Inflation Targeting and Sudden Stops, Issue 9599
National Bureau of Economic Research, 2003 - Inflation (Finance) - 24 pages
Emerging economies experience sudden stops in capital inflows. As we have argued in Caballero and Krishnamurthy (2002), having access to monetary policy during these sudden stops is useful, but mostly for "insurance" rather than for aggregate demand reasons. In this environment, a central bank that cannot commit to monetary policy choices will ignore the insurance aspect and follow a procyclical rather than the optimal countercyclical monetary policy. The central bank will also intervene excessively to support the exchange rate. These inefficiencies are exacerbated by the presence of an expansionary bias. In order to solve these problems, we propose modifying the central bank's objective to (i) include state-contingent inflation targets, (ii) target a measure of inflation that overweights non-tradable inflation, and (iii) weigh reserves holdings. Keywords: External Shocks, Domestic and International Liquidity, Inflation Targeting, Fear of Floating, Commitment, Underinsurance. JEL Classification: E0, E4, E5, F0, F3, F4, G1.
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a)if aggregate demand Barro-Gordon Caballero and Krishnamurthy Calvo and Reinhart capital inflows central bank chooses central bank's objective choice problem commitment solution countercyclical crises crisis decreasing domestic agents domestic borrowing capacity domestic interest rate effect on output Emerging Economies emerging markets equilibrium et+i|t exchange rate external fear of floating Financial Markets firms foreign framework H regime if'V incentives to insure increases output inflation targeting inject reserves Inside the back Instructions Inside interest parity condition interest rate choices international financial constraints international reserves investment Krishnamurthy 2002 loss function lowering interest rates Macroeconomics measure of inflation NBER Working Papers no-commitment nominal interest rate non-tradable inflation Number offset opportunity cost optimal monetary policy order condition output gap overweights papers in hard Partial Subscription price setters private sector's incentives rational expectations real interest rate reserves management sudden stop supply supply of dollars supply of funds ternational tradables zero