In this paper we examine the macroeconomic stability in a simple dynamic open economy model, in which monetary authorities adopt an flexible inflation-targeting regime in an environment with a liberalised capital account and flexible exchange rates. In this respect, inflation targeting is an essential part of a three-part policy (or trinity) that also includes flexible exchange rate and capital mobility. We show that a low degree of inflation targeting flexibility (i.e., central banks response is aggressive toward inflation) with a high degree of capital mobility implies a dynamically unstable solution in this simple rational expectations model. In contrast, when central bank adopts a high degree of inflation-targeting flexibility (accommodative central bank), stability can be ensured under any degree of capital mobility. Finally, under low degree of inflation targeting flexibility, it seems necessary to limit the degree of capital mobility in order to maintain stability in countries opening their economies to international capital flows, mainly in emerging market and transition economies.
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number
13858.
Find related papers by JEL classification: F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
References listed on IDEAS 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.:
Manfred J.M. Neumann & Jrgen von Hagen, 2002.
"Does inflation targeting matter?,"
Review,
Federal Reserve Bank of St. Louis, issue Jul, pages 127-148.
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