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Towards a “New” Inflation Targeting Framework: The Case of Uruguay

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  • Matias Escudero
  • Martin Gonzalez-Rozada
  • Martin Sola

Abstract

Using a dynamic stochastic general equilibrium model with financial frictions we study the effects of a rule that incorporates not only the interest rate but also the legal reserve requirements as instruments of the monetary policy. We evaluate the effectiveness of both instruments to accomplish the inflationary and/or financial stability objectives of the Central Bank of Uruguay. The main findings are that: (i) reserve requirements can be used to achieve the inflationary objectives of the Central Bank. However, reducing inflation using this instrument, it also produces a real appreciation of the Uruguayan peso; (ii) when the Central Bank uses the monetary policy rate as an instrument, the effect of the reserve requirements is to contribute to reduce the negative impact over consumption, investment and output of an eventual increase in this rate. Nevertheless, the quantitative results in terms of inflation reduction are rather poor; and (iii) the monetary policy rate becomes more effective to reduce inflation when the reserve requirement instrument is solely directed to achieve financial stability and the monetary policy rate used to achieve the inflationary target. Overall, the main policy conclusion of the paper is that having a non-conventional policy instrument, when well-targeted, can help effectively inflation control. Moving reserve requirements can also be instrumental in offsetting the impact of monetary policy on the real exchange rate.

Suggested Citation

  • Matias Escudero & Martin Gonzalez-Rozada & Martin Sola, 2014. "Towards a “New” Inflation Targeting Framework: The Case of Uruguay," Department of Economics Working Papers 2014_1, Universidad Torcuato Di Tella.
  • Handle: RePEc:udt:wpecon:2014_1
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    References listed on IDEAS

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    Cited by:

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    2. Cantú, Carlos & Gondo, Rocio & Martínez, Berenice, 2019. "Reserve requirements as a financial stability instrument," Working Papers 2019-014, Banco Central de Reserva del Perú.
    3. Primus, Keyra, 2017. "Excess reserves, monetary policy and financial volatility," Journal of Banking & Finance, Elsevier, vol. 74(C), pages 153-168.
    4. Santiago Camara, 2022. "TANK meets Diaz-Alejandro: Household heterogeneity, non-homothetic preferences & policy design," Papers 2201.02916, arXiv.org.

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    More about this item

    Keywords

    dynamic stochastic general equilibrium models; financial frictions; monetary policy; reserve requirements; inflation targeting; non-conventional policy instruments;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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