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Inflation Targeting and Sudden Stops

In: The Inflation-Targeting Debate

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  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Abstract

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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Suggested Citation

  • Ricardo J. Caballero & Arvind Krishnamurthy, 2004. "Inflation Targeting and Sudden Stops," NBER Chapters,in: The Inflation-Targeting Debate, pages 423-446 National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:9565
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    Cited by:

    1. Vasco Cúrdia, 2005. "Monetary Policy under Sudden Stops," International Finance 0510025, EconWPA, revised 19 Dec 2005.
    2. Ricardo Caballero & Kevin Cowan & Jonathan Kearns, 2005. "Fear of Sudden Stops: Lessons From Australia and Chile," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 8(4), pages 313-354.
    3. Ricardo Caballero & Stavros Panageas, 2006. "Contingent Reserves Management: An Applied Framework," Central Banking, Analysis, and Economic Policies Book Series,in: Ricardo Caballero & César Calderón & Luis Felipe Céspedes & Norman Loayza (Series Editor) & Klaus Sc (ed.), External Vulnerability and Preventive Policies, edition 1, volume 10, chapter 12, pages 399-420 Central Bank of Chile.
    4. Jeffrey Frankel, 2011. "A Comparison Of Product Price Targeting And Other Monetary Anchor Options, For Commodity Exporters In Latin America," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Fall 2011), pages 1-70, August.
    5. Hutchison, Michael M. & Noy, Ilan, 2006. "Sudden stops and the Mexican wave: Currency crises, capital flow reversals and output loss in emerging markets," Journal of Development Economics, Elsevier, vol. 79(1), pages 225-248, February.
    6. DETKEN Carsten & SMETS Frank, "undated". "Asset Price Booms and Monetary Policy," EcoMod2003 330700042, EcoMod.
    7. Fornaro, Luca, 2015. "Financial crises and exchange rate policy," Journal of International Economics, Elsevier, vol. 95(2), pages 202-215.
    8. Javier Gómez Pineda, 2004. "A Framework for Macroeconomic Stability in Emerging Market Economies," Borradores de Economia 320, Banco de la Republica de Colombia.
    9. Sebastian Edwards, 2006. "The Relationship Between Exchange Rates and Inflation Targeting Revisited," NBER Working Papers 12163, National Bureau of Economic Research, Inc.
    10. Tamim Bayoumi & Giovanni Dell'Ariccia & Karl F Habermeier & Tommaso Mancini Griffoli & Fabian Valencia, 2014. "Monetary Policy in the New Normal," IMF Staff Discussion Notes 14/3, International Monetary Fund.
    11. Lukáš Pfeifer & Zdeněk Pikhart, 2014. "Vztah finanční a cenové stability v podmínkách ČR
      [The Relationship of Financial and Price Stability in the Context of the Czech Republic]
      ," Politická ekonomie, University of Economics, Prague, vol. 2014(1), pages 49-66.
    12. Guillermo A. Calvo, 2006. "Monetary Policy Challenges in Emerging Markets: Sudden Stop, Liability Dollarization, and Lender of Last Resort," NBER Working Papers 12788, National Bureau of Economic Research, Inc.
    13. Jeffrey Frankel & Ben Smit & Federico Sturzenegger, 2008. "South Africa: Macroeconomic challenges after a decade of success," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 16(4), pages 639-677, October.
    14. Vasco Curdia, 2008. "Optimal Monetary Policy under Sudden Stops," 2008 Meeting Papers 474, Society for Economic Dynamics.
    15. Gilberto Libânio, 2008. "A Note on Inflation Targeting and Economic Growth in Brazil," Anais do XXXVI Encontro Nacional de Economia [Proceedings of the 36th Brazilian Economics Meeting] 200807211614210, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
    16. Javier Gómez, 2004. "Inflation Targeting and Sudden Stops," BORRADORES DE ECONOMIA 002854, BANCO DE LA REPÚBLICA.
    17. Jeffrey A. Frankel, 2010. "A Comparison of Monetary Anchor Options, Including Product Price Targeting, for Commodity-Exporters in Latin America," NBER Working Papers 16362, National Bureau of Economic Research, Inc.
    18. Guillermo A. Calvo, 2006. "Monetary Policy Challenges in Emerging Markets: Sudden Stop, Liability Dollarization, and Lender of Last Resort," NBER Working Papers 12788, National Bureau of Economic Research, Inc.
    19. Javier Gómez Pineda, 2004. "Inflation Targeting, Sudden Stops and the Cost of Fear of Floating," Borradores de Economia 276, Banco de la Republica de Colombia.
    20. Ricardo J. Caballero, 2006. "On the Macroeconomics of Asset Shortages," NBER Working Papers 12753, National Bureau of Economic Research, Inc.
    21. Tao Sun, 2015. "The Impact of Global Liquidity on Financial Landscapes and Risks in the ASEAN-5 Countries," IMF Working Papers 15/211, International Monetary Fund.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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