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The Structure of Inflation, Information and Labour Markets - Implications for monetary policy

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  • Ashima Goyal

    (Indira Gandhi Institute of Development Research)

Abstract

The paper gives a simplified version of a typical dynamic stochastic open economy general equilibrium models used to analyze optimal monetary policy. Then it outlines the chief modifications when dualism in labour and in consumption is introduced to adapt the model to a small open emerging market such as India. The implications of specific labour markets, and the structure of Indian inflation and its measurement are examined. Simulations give the welfare effects of different types of inflation targeting. Flexible CPI inflation targeting (CIT) without lags works best, especially if the economy is more open. But volatile terms of trade make the supply curve even steeper than in a small open economy despite specific labour markets and higher labour supply elasticity. Exchange rate intervention limits the volatility of the terms of trade and improves outcomes, making the supply curve flatter. As long as such intervention is required, domestic inflation targeting (DIT) continues to be more robust and effective. The welfare losses from the lags in CPI, which prevent the implementation of CIT, are low as long as the dualistic structure dominates. As the economy becomes more open, however, the loss from not being able to use CIT rises. The lags in CPI therefore need to be reduced, making its future use possible.

Suggested Citation

  • Ashima Goyal, 2008. "The Structure of Inflation, Information and Labour Markets - Implications for monetary policy," Macroeconomics Working Papers 22378, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:macroe:22378
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    References listed on IDEAS

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    1. Arminio Fraga & Ilan Goldfajn & André Minella, 2004. "Inflation Targeting in Emerging Market Economies," NBER Chapters,in: NBER Macroeconomics Annual 2003, Volume 18, pages 365-416 National Bureau of Economic Research, Inc.
    2. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    3. Ashima Goyal, 2009. "The Natural Interest Rate In Emerging Markets," World Scientific Book Chapters,in: New And Enduring Themes In Development Economics, chapter 15, pages 333-368 World Scientific Publishing Co. Pte. Ltd..
    4. Ashima Goyal, 2005. "Incentives from exchange rate regimes in an institutional context," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2005-002, Indira Gandhi Institute of Development Research, Mumbai, India.
    5. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    6. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Closed versus Open Economies: An Integrated Approach," NBER Working Papers 8604, National Bureau of Economic Research, Inc.
    7. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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    Cited by:

    1. Ashima Goyal, 2012. "The Future Of Financial Liberalization In South Asia," Asia-Pacific Development Journal, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP), vol. 19(1), pages 63-96, June.
    2. Ashima Goyal, 2011. "Sustainable debt and deficits in Emerging Markets," International Journal of Trade and Global Markets, Inderscience Enterprises Ltd, vol. 4(2), pages 113-136.
    3. Mishra, Ankita & Mishra, Vinod, 2012. "Evaluating inflation targeting as a monetary policy objective for India," Economic Modelling, Elsevier, vol. 29(4), pages 1053-1063.

    More about this item

    Keywords

    small open emerging market; optimal monetary policy; dualistic labour markets; inflation; measurement lags; specific labour markets;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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