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Balance of Payments Crises Under Inflation Targeting

  • Shujing Li
  • Isabel K. Yan
  • Michael Kumhof

This paper analyzes a small open economy model under inflation targeting. It shows why such a monetary regime is vulnerable to speculative attacks that take place over a short period rather than instantaneously. The speed at which the regime collapses, and the extent of reserve losses, are increasing in the central bank's explicit or implicit commitment to intervene in the foreign exchange market. Attacks are therefore ranked, from most to least severe, as follows: Exchange rate targeting, CPI inflation targeting, domestic nontradables inflation targeting, and money targeting. Under inflation targeting the size of the attack is increasing in the tradables consumption share.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/84.

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Length: 26
Date of creation: 01 Apr 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/84
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  1. Froot, Kenneth A & Klemperer, Paul D, 1989. "Exchange Rate Pass-Through When Market Share Matters," American Economic Review, American Economic Association, vol. 79(4), pages 637-54, September.
  2. Paul Krugman, 1996. "Are Currency Crises Self-Fulfilling?," NBER Chapters, in: NBER Macroeconomics Annual 1996, Volume 11, pages 345-407 National Bureau of Economic Research, Inc.
  3. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
  4. Bennett T. McCallum, 1996. "Inflation Targeting in Canada, New Zealand, Sweden, the United Kingdom, and in General," NBER Working Papers 5579, National Bureau of Economic Research, Inc.
  5. Minella, Andre & de Freitas, Paulo Springer & Goldfajn, Ilan & Muinhos, Marcelo Kfoury, 2003. "Inflation targeting in Brazil: constructing credibility under exchange rate volatility," Journal of International Money and Finance, Elsevier, vol. 22(7), pages 1015-1040, December.
  6. Guillermo A. Calvo & Carlos A. Vegh, 1999. "Inflation Stabilization and BOP Crises in Developing Countries," NBER Working Papers 6925, National Bureau of Economic Research, Inc.
  7. Miguel A Savastano & Paul R Masson & Sunil Sharma, 1997. "The Scope for Inflation Targeting in Developing Countries," IMF Working Papers 97/130, International Monetary Fund.
  8. Carmen M. Reinhart, 2000. "Mirage of Floating Exchange Rates," American Economic Review, American Economic Association, vol. 90(2), pages 65-70, May.
  9. Enrique G. Mendoza, 2006. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," IMF Working Papers 06/88, International Monetary Fund.
  10. Jose De Gregorio & Alberto Giovannini, 1993. "International Evidence on Tradables and Nontradable Inflation," NBER Working Papers 4438, National Bureau of Economic Research, Inc.
  11. Maurice Obstfeld, 1984. "Speculative Attack and the External Constraint in a Maximizing Model of the Balance of Payments," NBER Working Papers 1437, National Bureau of Economic Research, Inc.
  12. Enrique G. Mendoza & Martin Uribe, 1999. "The Business Cycles of Balance-of-Payment Crises: A Revision of Mundellan Framework," NBER Working Papers 7045, National Bureau of Economic Research, Inc.
  13. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  14. Mishkin, Frederic S. & Savastano, Miguel A., 2001. "Monetary policy strategies for Latin America," Journal of Development Economics, Elsevier, vol. 66(2), pages 415-444, December.
  15. Jordi Galí & Tommaso Monacelli, 2003. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Working Papers 11, Barcelona Graduate School of Economics.
  16. Calvo, Guillermo A, 1987. "Balance of Payments Crises in a Cash-in-Advance Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(1), pages 19-32, February.
  17. Avinash Dixit, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 205-228.
  18. Mendoza, Enrique G. & Uribe, Martin, 2000. "Devaluation risk and the business-cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 239-296, December.
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