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The Structure of Inflation, Information and Labour Markets - Implications for monetary policy

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  • Ashima Goyal

    (Indira Gandhi Institute of Development Research)

Abstract

The paper gives a simplified version of a typical dynamic stochastic open economy general equilibrium models used to analyze optimal monetary policy. Then it outlines the chief modifications when dualism in labour and in consumption is introduced to adapt the model to a small open emerging market such as India. The implications of specific labour markets, and the structure of Indian inflation and its measurement are examined. Simulations give the welfare effects of different types of inflation targeting. Flexible CPI inflation targeting (CIT) without lags works best, especially if the economy is more open. But volatile terms of trade make the supply curve even steeper than in a small open economy despite specific labour markets and higher labour supply elasticity. Exchange rate intervention limits the volatility of the terms of trade and improves outcomes, making the supply curve flatter. As long as such intervention is required, domestic inflation targeting (DIT) continues to be more robust and effective. The welfare losses from the lags in CPI, which prevent the implementation of CIT, are low as long as the dualistic structure dominates. As the economy becomes more open, however, the loss from not being able to use CIT rises. The lags in CPI therefore need to be reduced, making its future use possible.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 22378.

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Date of creation: Jan 2008
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Handle: RePEc:eab:macroe:22378

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Related research

Keywords: small open emerging market; optimal monetary policy; dualistic labour markets; inflation; measurement lags; specific labour markets;

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References

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  1. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  2. Ashima Goyal, 2008. "The Natural Interest Rate in Emerging Markets," Macroeconomics Working Papers 22379, East Asian Bureau of Economic Research.
  3. Arminio Fraga & Ilan Goldfajn & Andre Minella, 2003. "Inflation Targeting in Emerging Market Economies," NBER Working Papers 10019, National Bureau of Economic Research, Inc.
  4. Ashima Goyal, 2006. "Incentives from Exchange Rate Regimes in an Institutional Context," Macroeconomics Working Papers 22375, East Asian Bureau of Economic Research.
  5. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  6. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Closed versus Open Economies: An Integrated Approach," NBER Working Papers 8604, National Bureau of Economic Research, Inc.
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Cited by:
  1. Goyal, Ashima, 2010. "Sustainable debt and deficits in emerging markets," MPRA Paper 40100, University Library of Munich, Germany.
  2. Ashima Goyal, 2010. "The Future of financial liberalization in South Asia," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2010-022, Indira Gandhi Institute of Development Research, Mumbai, India.
  3. Mishra, Ankita & Mishra, Vinod, 2012. "Evaluating inflation targeting as a monetary policy objective for India," Economic Modelling, Elsevier, vol. 29(4), pages 1053-1063.

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