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Towards a “New” Inflation Targeting Framework: The Case of Uruguay

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  • Matias Escudero

    ()

  • Martin Gonzalez-Rozada

    ()

  • Martin Sola

    ()

Abstract

Using a dynamic stochastic general equilibrium model with financial frictions we study the effects of a rule that incorporates not only the interest rate but also the legal reserve requirements as instruments of the monetary policy. We evaluate the effectiveness of both instruments to accomplish the inflationary and/or financial stability objectives of the Central Bank of Uruguay. The main findings are that: (i) reserve requirements can be used to achieve the inflationary objectives of the Central Bank. However, reducing inflation using this instrument, it also produces a real appreciation of the Uruguayan peso; (ii) when the Central Bank uses the monetary policy rate as an instrument, the effect of the reserve requirements is to contribute to reduce the negative impact over consumption, investment and output of an eventual increase in this rate. Nevertheless, the quantitative results in terms of inflation reduction are rather poor; and (iii) the monetary policy rate becomes more effective to reduce inflation when the reserve requirement instrument is solely directed to achieve financial stability and the monetary policy rate used to achieve the inflationary target. Overall, the main policy conclusion of the paper is that having a non-conventional policy instrument, when well-targeted, can help effectively inflation control. Moving reserve requirements can also be instrumental in offsetting the impact of monetary policy on the real exchange rate.

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Bibliographic Info

Paper provided by Universidad Torcuato Di Tella in its series Department of Economics Working Papers with number wp201401.

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Length: 89 pages
Date of creation: Jan 2014
Date of revision:
Handle: RePEc:udt:wpecon:wp201401

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Web page: http://www.utdt.edu/ver_contenido.php?id_contenido=439&id_item_menu=568
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Keywords: dynamic stochastic general equilibrium models; financial frictions; monetary policy; reserve requirements; inflation targeting; non-conventional policy instruments;

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  1. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 273-285, November.
  2. Christian Glocker & Pascal Towbin, 2012. "Reserve Requirements for Price and Financial Stability: When Are They Effective?," International Journal of Central Banking, International Journal of Central Banking, vol. 8(1), pages 65-114, March.
  3. International Monetary Fund, 2011. "Uruguay," IMF Staff Country Reports 11/63, International Monetary Fund.
  4. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
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