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"Good governance" in monetary policy and the negative real effects of inflation targeting in developing economies

  • Gilberto Libanio

    (Cedeplar-UFMG)

This paper analyzes the growth effects of inflation targeting regimes in emerging market economies. In particular, it focuses on the case of three Latin American economies where the inflation targeting framework has been implemented, namely Brazil, Chile and Mexico. It is argued that not only monetary policy is procyclical under inflation targeting, but also that it is likely to react in an asymmetric way to fluctuations in economic activity and exchange rates (too ‘tight’ during recessions, not so ‘loose’ during expansions). Such pattern may generate a downward bias in aggregate demand, with negative long-run real effects on output growth and employment. Our results suggest that monetary policy is procyclical in Brazil and Chile, and countercyclical in Mexico. Also, they suggest that monetary policy has reacted asymmetrically to economic activity in the three countries. The main economic policy implication of this study is that central banks should consider more seriously the effects of monetary policy on output and employment.

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Paper provided by Cedeplar, Universidade Federal de Minas Gerais in its series Textos para Discussão Cedeplar-UFMG with number td277.

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Length: 27 pages
Date of creation: Dec 2005
Date of revision:
Handle: RePEc:cdp:texdis:td277
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