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Open-Economy Inflation Targeting

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  • Svensson, Lars E.O.

    (Institute for International Economic Studies, Stockholm University)

Abstract

The paper extends previous analysis of closed-economy inflation targeting to a small open economy with forward-looking aggregate supply and demand with some microfoundations, and with stylized realistic lags in the different transmission channels for monetary policy. The paper compares targeting of CPI and domestic inflation, strict and flexible inflation targeting, and inflation-targeting reaction functions and the Taylor rule. The optimal monetary policy response to several different shocks is examined. Flexible CPI-inflation targeting stands out as successful in limiting not only the variability of CPI inflation but also the variability of the output gap, and induce similar monetary policy responses. The model gives limited support for a so-called monetary conditions index, MCI, of the monetary-policy impact on aggregate demand, but the impact on inflation is too complex to be acptured by any single index. The index differs from currently used indices in combining (1) a long rather than a short real interest rate with the real exchange rate and (2) expected future values rather than current values. Because of (2), the index is not directly observable and verifiable to external observers.

Suggested Citation

  • Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies.
    • Handle: RePEc:hhs:iiessp:0638
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    inflation targeting; forward-looking;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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