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Inflation persistence: Implications for a design of monetary policy in a small open economy subject to external shocks

  • Karlygash Kuralbayeva

    ()

    (Lincoln College, University of Oxford)

We analyze implications of in.ation persistence for business cycle dynamics following terms of trade and risk-premium shocks in a small open economy, under fixed and flexible exchange rate regimes. We show that the country's adjustment paths are slow and cyclical if there is a signi.cant backward-looking element in the in.ation dynamics and the exchange rate is fixed. We also show that such cyclical adjustment paths are moderated if there is a high proportion of forward-looking price setters. In contrast, with an independent monetary policy, flexible exchange rate allows to escape severe cycles, supporting the conventional wisdom about the insulation role of flexible exchange rates.

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Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 93.

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Length: 46
Date of creation: 20 Feb 2007
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Handle: RePEc:rtv:ceisrp:93
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