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Monetary policy trilemma, inflation targeting and global financial crisis

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  • Eda Gülşen
  • Erdal Özmen

Abstract

We empirically investigate the validity of the monetary policy trilemma postulation for emerging market (EME) and advanced (AE) economies under different exchange rate and monetary policy regimes before and after the recent global financial crisis (GFC). Consistent with the dilemma proposition, domestic interest rates are determined by global financial conditions and the FED rate even under floating exchange rate regimes (ERR) in the long‐run. The impact of the FED rates is higher in EME than AE and EME are much more sensitive to global financial cycle under managed than floating ERR. The spillover from the FED rate substantially increases after the GFC in EME with floating ERR and AE. The results from the monetary policy reaction functions based on equilibrium correction mechanism specifications suggest that domestic interest rates respond to inflation and output gaps especially under inflation targeting (IT) in the short‐run. The response to inflation gap tends to be smaller in IT AE after the GFC.

Suggested Citation

  • Eda Gülşen & Erdal Özmen, 2020. "Monetary policy trilemma, inflation targeting and global financial crisis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 25(2), pages 286-296, April.
    • Handle: RePEc:wly:ijfiec:v:25:y:2020:i:2:p:286-296
    DOI: 10.1002/ijfe.1752
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