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Small Open Economies with Frictions in Credit Markets: Target inflation or money growth when floating?

  • Paula Hernandez-Verme

    ()

    (Department of Economics and Finance, Universidad de Guanajuato)

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    I compare the relative merits of a policy of inflation targeting for small open economies with frictions in financial markets with an alternative floating regime that has a constant rate of domestic money growth. The differences between these two policies appear only in the dynamic properties of equilibria with credit rationing. When the probability of loan repayment is low, inflation targeting eliminates endogenous volatility when compared with a constant money growth, but equilibria remain indeterminate. When the probability of loan repayment is high, inflation targeting always improves on the stability of equilibria, and sometimes it also eliminates endogenous fluctuations.

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    File URL: http://economia.ugto.org/WorkingPapers/EC200903.pdf
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    Paper provided by Universidad de Guanajuato, Department of Economics and Finance in its series Department of Economics and Finance Working Papers with number EC200903.

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    Length: 37 pages
    Date of creation: Jul 2009
    Date of revision:
    Handle: RePEc:gua:wpaper:ec200903
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    1. Hernandez-Verme, Paula, 2002. "Inflation, Growth and Exchange Rate Regimes in Small Open Economies," MPRA Paper 16699, University Library of Munich, Germany, revised Aug 2009.
    2. Bullard, James & Keating, John W., 1995. "The long-run relationship between inflation and output in postwar economies," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 477-496, December.
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