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Inflation Targeting and Sudden Stops

  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Emerging economies experience sudden stops in capital inflows. As we have argued in Caballero and Krishnamurthy (2002), having access to monetary policy during these sudden stops is useful, but mostly for insurance' rather than for aggregate demand reasons. In this environment, a central bank that cannot commit to monetary policy choices will ignore the insurance aspect and follow a procyclical rather than the optimal countercyclical monetary policy. The central bank will also intervene excessively to support the exchange rate. These inefficiencies are exacerbated by the presence of an expansionary bias. In order to solve these problems, we propose modifying the central bank's objective to (i) include state-contingent inflation targets, (ii) target a measure of inflation that overweights non-tradable inflation

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9599.

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Date of creation: Apr 2003
Date of revision:
Publication status: published as Inflation Targeting and Sudden Stops , Ricardo J. Caballero, Arvind Krishnamurthy. in The Inflation-Targeting Debate , Bernanke and Woodford. 2005
Handle: RePEc:nbr:nberwo:9599
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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
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  8. Christiano, Lawrence J. & Gust, Christopher & Roldos, Jorge, 2004. "Monetary policy in a financial crisis," Journal of Economic Theory, Elsevier, vol. 119(1), pages 64-103, November.
  9. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
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  11. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February.
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