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Inflation Targeting and Sudden Stops

In: The Inflation-Targeting Debate

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  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Abstract

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

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This chapter was published in:

  • Ben S. Bernanke & Michael Woodford, 2004. "The Inflation-Targeting Debate," NBER Books, National Bureau of Economic Research, Inc, number bern04-1, May.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 9565.

    Handle: RePEc:nbr:nberch:9565

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    1. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
    2. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
    3. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc.
    4. Svensson, L.E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Papers 646, Stockholm - International Economic Studies.
    5. Lawrence J. Christiano & Christopher Gust & Jorge Roldos, 2002. "Monetary policy in a financial crisis," Working Paper 0204, Federal Reserve Bank of Cleveland.
    6. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    7. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
    8. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
    9. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    10. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February.
    11. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
    12. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
    13. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
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