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A Critical View of Inflation Targeting: Crises, Limited Sustainability, and Aggregate Shocks

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Michael Kumhof

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Abstract

This paper presents a critical appraisal of inflation targeting as a monetary policy regime for emerging markets. It is shown that this policy, if understood as a strict commitment to a CPI inflation target, shares many features with exchange rate targeting and is quite different from flexible exchange rates under money growth rules. Inflation targets are vulnerable to speculative attacks, although less so than exchange rate targets. They perform worse than exchange rate targets when policy sustainability is limited. And their relative performance under exogenous shocks, not surprisingly, depends on the nature and direction of those shocks. Given this lack of an obvious advantage over exchange rate targets, the real attraction of inflation targets may be that they give the policymaker discretion. This, in the context of many emerging markets, has to be a cause for concern.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 127.

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Date of creation: Nov 2001
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Handle: RePEc:chb:bcchwp:127

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  1. Guillermo A. Calvo & Carlos A. Vegh, 1999. "Inflation Stabilization and BOP Crises in Developing Countries," NBER Working Papers 6925, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Reinhart, Carmen, 2000. "The mirage of floating exchange rates," MPRA Paper 13736, University Library of Munich, Germany. [Downloadable!]
  3. Carmen M. Reinhart, 2000. "Mirage of Floating Exchange Rates," American Economic Review, American Economic Association, vol. 90(2), pages 65-70, May. [Downloadable!] (restricted)
  4. Paul R. Masson, 1997. "The Scope for Inflation Targeting in Developing Countries," IMF Working Papers 97/130, International Monetary Fund.
  5. Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "Stabilization Policy and the Costs of Dollarization," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 482-509, May.
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  6. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Bennett T. McCallum, 1998. "Inflation Targeting in Canada, New Zealand, Sweden, the United Kingdom, and in General," NBER Working Papers 5579, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Enrique G. Mendoza, 2000. "On the Benefits of Dollarization when Stabilization Policy is not Credible and Financial Markets are Imperfect," NBER Working Papers 7824, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Michael Kumhof & Shujing Li & Isabel Yan, . "Balance of Payments Crises Under Inflation Targeting," Working Papers 00020, Stanford University, Department of Economics. [Downloadable!]
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  11. Eric Parrado, 2004. "Inflation Targeting and Exchange Rate Rules in an Open Economy," IMF Working Papers 04/21, International Monetary Fund. [Downloadable!]
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  16. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April. [Downloadable!] (restricted)
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  17. Jose De Gregorio & Holger C. Wolf & Alberto Giovannini, 1994. "International Evidence on Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
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  18. Michael Kumhof, 2000. "Inflation Targeting and Exchange Rate Flexibility," Working Papers 00023, Stanford University, Department of Economics. [Downloadable!]
  19. Valerie R. Bencivenga & Elisabeth Huybens & Bruce D. Smith, 2002. "What to stabilize in the open economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(4), pages 1289-1307, November. [Downloadable!] (restricted)
  20. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fixing for Your Life," NBER Working Papers 8006, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1078-1098, October. [Downloadable!] (restricted)
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  22. Paul Krugman, 1996. "Are Currency Crises Self-Fulfilling?," NBER Chapters, in: NBER Macroeconomics Annual 1996, Volume 11, pages 345-407 National Bureau of Economic Research, Inc. [Downloadable!]
  23. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  24. Eckstein, Zvi & Leiderman, Leonardo, 1992. "Seigniorage and the welfare cost of inflation: Evidence from an intertemporal model of money and consumption," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 389-410, June. [Downloadable!] (restricted)
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  25. Maurice Obstfeld, 1986. "Speculative Attack and the External Constraint in a Maximizing Model of the Balance of Payments," NBER Working Papers 1437, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  26. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
  27. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  28. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August. [Downloadable!] (restricted)
  29. Bergin, Paul R. & Feenstra, Robert C., 2000. "Staggered price setting, translog preferences, and endogenous persistence," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 657-680, June. [Downloadable!] (restricted)
  30. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nicoletta Batini & Douglas Laxton, 2006. "Under What Conditions Can Inflation Targeting Be Adopted? The Experience of Emerging Markets," Working Papers Central Bank of Chile 406, Central Bank of Chile. [Downloadable!]
  2. Reginaldo P. Nogueira Jnr, 2006. "Inflation Targeting and the Role of Exchange Rate Pass-through," Studies in Economics 0602, Department of Economics, University of Kent. [Downloadable!]
  3. Harold Codrington & Roland Craigwell & Kevin Greenidge & DeLisle Worrell, 2003. "Economic Resilience with an Exchange Rate Peg: the Barbados Experience, 1985-2000," IMF Working Papers 03/168, International Monetary Fund. [Downloadable!]
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