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Inflation Targeting with Sovereign Default Risk

Author

Listed:
  • Cristina Arellano

    (Federal Reserve Bank of Minneapolis)

  • Gabriel Mihalache

    (Stony Brook University)

  • Yan Bai

    (University of Rochester)

Abstract

During the 1980s and 1990s emerging markets experienced recurrent episodes of high inflation and debt crises with high sovereign default premia, and many default events. Since the 2000s, inflation has come down in many of these emerging markets and debt crises have been limited. These developments have occurred as central banks in emerging markets have become more independent and have adopted a monetary policy of setting interest rates to target inflation. In this paper we study the interplay of monetary policy and sovereign default risk and show that inflation target induce not only lower inflation rates but also lower default risk of sovereign debt.

Suggested Citation

  • Cristina Arellano & Gabriel Mihalache & Yan Bai, 2018. "Inflation Targeting with Sovereign Default Risk," 2018 Meeting Papers 851, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:851
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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