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Is inflation targeting operative in an open economy setting?

Author

Listed:
  • Esteban Pérez Caldentey

    (Economic Commission for Latin American and the Caribbean)

  • Matías Vernengo

    (Bucknell University)

Abstract

The justification for inflation targeting rests on three core propositions. The first is called 'lean against the wind,' which refers to fact that the monetary authority contracts (expands) aggregate demand below capacity when the actual rate of inflation is above (below) target. The second is 'the divine coincidence,' which means that stabilizing the rate of inflation around its target is tantamount to stabilizing output around its full employment level. The third proposition is that of stability. This means that the inflation target is part of an equilibrium configuration which generates convergence following any small disturbance to its initial conditions. These propositions are derived from a closed economy setting which is not representative of the countries that have actually adopted inflation targeting frameworks. Currently there are 27 countries, 9 of which are classified as industrialized and 18 as developing countries that have explicitly implemented a fully fledged inflation targeting regime (FFIT). These countries are open economies and are concerned by the evolution of the external sector and the exchange rate as proven by their interventions in the foreign exchange markets. We show that these three core propositions and the practice of inflation targeting are inoperative in an open economy context.

Suggested Citation

  • Esteban Pérez Caldentey & Matías Vernengo, 2013. "Is inflation targeting operative in an open economy setting?," Review of Keynesian Economics, Edward Elgar Publishing, vol. 1(3), pages 347-369, January.
    • Handle: RePEc:elg:rokejn:v:1:y:2013:i:3:p347-369
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    Cited by:

    1. Fernando Ferrari Filho, Marcelo Milan, 2018. "Excess Real Interest Rates and the Inflation Targeting Regime in Brazil: Monetary Policy Ineffectiveness and Rentiers¡¯ Interests," Applied Economics and Finance, Redfame publishing, vol. 5(6), pages 84-100, November.
    2. Mark Setterfield, 2014. "Using Interest Rates as the Instrument of Monetary Policy: Beware Real effects, Positive Feedbacks, and Discontinuities," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(70), pages 7-22, June.
    3. Martín Abeles & Demian Panigo, 2015. "Dealing with cost-push inflation in Latin America: multi-causality in a context of increased openness and commodity price volatility," Review of Keynesian Economics, Edward Elgar Publishing, vol. 3(4), pages 517—535-5, October.
    4. Nunes, Débora & Arora, Diksha & Braunstein, Elissa, 2025. "Real effective exchange rate shocks and job quality by gender in Latin America," Structural Change and Economic Dynamics, Elsevier, vol. 74(C), pages 262-273.
    5. Samuele Bibi & Sebastian Valdecantos, 2023. "The Price (and Costs) of Macroeconomic Stability in Peru: Some Lessons on the Implications of FDI‐driven Growth," Development and Change, International Institute of Social Studies, vol. 54(5), pages 1136-1168, September.
    6. Bibi, Samuele & Valdecantos, Sebastián, 2023. "The price (and costs) of macroeconomic stability in Peru: Some lessons on the implications of FDI-driven growth," Nülan. Deposited Documents 4078, Universidad Nacional de Mar del Plata, Facultad de Ciencias Económicas y Sociales, Centro de Documentación.

    More about this item

    Keywords

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    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Systems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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