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Inflation Targeting and Sudden Stops

In: The Inflation-Targeting Debate

  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Emerging economies experience sudden stops in capital inflows. As we have argued in Caballero and Krishnamurthy (2002), having access to monetary policy during these sudden stops is useful, but mostly for insurance' rather than for aggregate demand reasons. In this environment, a central bank that cannot commit to monetary policy choices will ignore the insurance aspect and follow a procyclical rather than the optimal countercyclical monetary policy. The central bank will also intervene excessively to support the exchange rate. These inefficiencies are exacerbated by the presence of an expansionary bias. In order to solve these problems, we propose modifying the central bank's objective to (i) include state-contingent inflation targets, (ii) target a measure of inflation that overweights non-tradable inflation

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This chapter was published in:
  • Ben S. Bernanke & Michael Woodford, 2004. "The Inflation-Targeting Debate," NBER Books, National Bureau of Economic Research, Inc, number bern04-1, May.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 9565.
    Handle: RePEc:nbr:nberch:9565
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    1. Michael P. Dooley, 1998. "A model of crises in emerging markets," International Finance Discussion Papers 630, Board of Governors of the Federal Reserve System (U.S.).
    2. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    3. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
    4. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
    5. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
    6. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
    7. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
    8. Christiano, Lawrence J. & Gust, Christopher & Roldos, Jorge, 2004. "Monetary policy in a financial crisis," Journal of Economic Theory, Elsevier, vol. 119(1), pages 64-103, November.
    9. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
    10. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2003. "External Constraints on Monetary Policy and the Financial Accelerator," NBER Working Papers 10128, National Bureau of Economic Research, Inc.
    11. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    12. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
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