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Inflation Targeting, Capital Mobility and Macroeconomic Stability

  • Dai, Meixing
  • Sidiropoulos, Moïse

In this paper we examine the macroeconomic stability in a simple dynamic open economy model, in which monetary authorities adopt an flexible inflation-targeting regime in an environment with a liberalised capital account and flexible exchange rates. In this respect, inflation targeting is an essential part of a three-part policy (or trinity) that also includes flexible exchange rate and capital mobility. We show that a low degree of inflation targeting flexibility (i.e., central bank�s response is aggressive toward inflation) with a high degree of capital mobility implies a dynamically unstable solution in this simple rational expectations model. In contrast, when central bank adopts a high degree of inflation-targeting flexibility (accommodative central bank), stability can be ensured under any degree of capital mobility. Finally, under low degree of inflation targeting flexibility, it seems necessary to limit the degree of capital mobility in order to maintain stability in countries opening their economies to international capital flows, mainly in emerging market and transition economies.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13858.

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Date of creation: Jul 2003
Date of revision: May 2005
Handle: RePEc:pra:mprapa:13858
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  1. Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One decade of inflation targeting in the world : What do we know and what do we need to know?," Working Papers Central Bank of Chile 101, Central Bank of Chile.
  2. Frederic S. Mishkin & Adam S. Posen, 1998. "Inflation Targeting: Lessons from Four Countries," NBER Working Papers 6126, National Bureau of Economic Research, Inc.
  3. Frederic S. Mishkin, 2000. "Inflation Targeting in Emerging Market Countries," NBER Working Papers 7618, National Bureau of Economic Research, Inc.
  4. Frederic S. Mishkin & Miguel A. Savastano, 2000. "Monetary Policy Strategies for Latin America," NBER Working Papers 7617, National Bureau of Economic Research, Inc.
  5. Batini, Nicoletta & Harrison, Richard & Millard, Stephen P., 2003. "Monetary policy rules for an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11-12), pages 2059-2094, September.
  6. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  7. John Williamson, 2000. "Exchange Rate Regimes for Emerging Markets: Reviving the Intermediate Option," Peterson Institute Press: Policy Analyses in International Economics, Peterson Institute for International Economics, number pa60, 03.
  8. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  9. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
  10. Vittorio Corbo & Klaus Schmidt-Hebbel, 2002. "Inflation Targeting in Latin America," Documentos de Trabajo 230, Instituto de Economia. Pontificia Universidad Católica de Chile..
  11. Barry Eichengreen, 2002. "Can Emerging Markets Float? Should They Inflation Target?," Working Papers Series 36, Central Bank of Brazil, Research Department.
  12. Amato, Jeffery D. & Gerlach, Stefan, 2002. "Inflation targeting in emerging market and transition economies: Lessons after a decade," European Economic Review, Elsevier, vol. 46(4-5), pages 781-790, May.
  13. Lars E O Svensson, 1997. "Inflation targeting in an open economy: strict or flexible inflation targeting?," Reserve Bank of New Zealand Discussion Paper Series G97/8, Reserve Bank of New Zealand.
  14. Laurence Ball, 1998. "Policy Rules for Open Economies," RBA Research Discussion Papers rdp9806, Reserve Bank of Australia.
  15. Manfred J.M. Neumann & Jrgen von Hagen, 2002. "Does inflation targeting matter?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 127-148.
  16. John B. Taylor, 1996. "How should monetary policy respond to shocks while maintaining long-run price stability? Conceptual issues," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 181-195.
  17. Wyplosz, Charles, 2001. "Exchange Rate Regimes: Some Lessons from Postwar Europe," CEPR Discussion Papers 2723, C.E.P.R. Discussion Papers.
  18. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  19. 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.
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