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Inflation Targeting, Sudden Stops and the Cost of Fear of Floating

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Author Info
Javier Gómez Pineda ()
Abstract

Sudden stops seem to create the perfect environment for disinflation, especially when central banks defend the exchange rate by increasing interest rates. We propose a variation of the output gap model that incorporates the sudden stop shock. The use of the model in policy analysis shows that fear of floating is pro-cyclical and inflation targeting, counter-cyclical. The model is run for Brazil, Colombia, Korea and Thailand, the inflation targeting countries that have recently had sudden stops. The three policy implications direct attention to the medium and long run. First,the central banks that are targeting inflation should focus on inflation, not during but after the sudden stop. Second, they could complement this medium term view by monitoring a measure of inflation of non traded goods. Third, the monetary authorities could eventually introduce an escape clause to the CPI inflation target under a sharp depreciation.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 276.

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Handle: RePEc:bdr:borrec:276

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Find related papers by JEL classification:
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F3 - International Economics - - International Finance
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation

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