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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.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 9565.
    Handle: RePEc:nbr:nberch:9565
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    3. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 35-54, November.
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    11. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
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