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Coordination between monetary policy and fiscal policy for an inflation targeting emerging market

  • Aktas, Zelal
  • Kaya, Neslihan
  • Özlale, Ümit

Several studies including Blanchard (2004) and Favero and Giavazzi (2004) imply that in emerging market economies, a tight monetary policy within an inflation-targeting framework could actually increase the price level due to the lack of fiscal discipline and the associated high risk premium. We extend their arguments in two ways. First, we introduce a semi structural model with time-varying parameters, where the risk premium is 'unobserved' and it is derived within the system. Such an approach fits better with the volatile nature of emerging market economies by allowing us to track down the time-varying effects of macroeconomic dynamics on both the model-consistent risk premium and the other key variables. Second, we obtain impulse response functions and analyze the implications of a tight monetary policy on major macroeconomic variables. Taking the Turkish economy as our reference point, we find that the arguments of Blanchard (2004) and Favero and Giavazzi (2004) seem to be valid.

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File URL: http://www.sciencedirect.com/science/article/pii/S0261-5606(09)00081-3
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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 29 (2010)
Issue (Month): 1 (February)
Pages: 123-138

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Handle: RePEc:eee:jimfin:v:29:y:2010:i:1:p:123-138
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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  1. Carmen M. Reinhart, 2002. "Default, Currency Crises and Sovereign Credit Ratings," NBER Working Papers 8738, National Bureau of Economic Research, Inc.
  2. Rudebusch, Glenn & Svensson, Lars, 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," Seminar Papers 672, Stockholm University, Institute for International Economic Studies.
  3. Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies.
  4. Favero, Carlo A. & Giavazzi, Francesco, 2004. "Inflation Targeting and Debt: Lessons from Brazil," CEPR Discussion Papers 4376, C.E.P.R. Discussion Papers.
  5. Pierre-Olivier Gourinchas & Hélène Rey, 2007. "International Financial Adjustment," Journal of Political Economy, University of Chicago Press, vol. 115(4), pages 665-703, 08.
  6. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, March.
  7. Bergin, Paul R., 2006. "How well can the New Open Economy Macroeconomics explain the exchange rate and current account?," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 675-701, August.
  8. Hakan Kara & Fethi Ogunc & Umit Ozlale & Cagri Sarikaya, 2007. "Estimating the Output Gap in a Changing Economy," Southern Economic Journal, Southern Economic Association, vol. 74(1), pages 269-289, July.
  9. Olivier Blanchard, 2004. "Fiscal Dominance and Inflation Targeting: Lessons from Brazil," NBER Working Papers 10389, National Bureau of Economic Research, Inc.
  10. Hakan Kara & Hande Küçük-Tuger & Ümit Özlale & Burç Tuger & Eray M. Yücel, 2007. "Exchange Rate Regimes And Pass-Through: Evidence From The Turkish Economy," Contemporary Economic Policy, Western Economic Association International, vol. 25(2), pages 206-225, 04.
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