Inflation Targeting and Exchange Rate Rules in an Open Economy

February 1, 2004

Preview Citation

Format: Chicago

Eric Parrado. Inflation Targeting and Exchange Rate Rules in an Open Economy, (USA: International Monetary Fund, 2004) accessed December 22, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper provides a simple dynamic neo-Keynesian model that can be used to analyze the impact of monetary policy that considers inflation targeting in a small open economy. This economy is characterized by imperfect competition and short-run price rigidity. The main findings of the paper are that, depending on what shocks affect the economy, the effects of inflation targeting on output and inflation volatility depend crucially on the exchange rate regime and the inflation index being targeted. First, in the presence of real shocks, flexible exchange rates dominate managed exchange rates, while for nominal shocks the reverse is true. Second, domestically generated inflation targeting is preferable to CPI inflation targeting, because the former is more stabilizing not only in relation to both measures of inflation, but also to the output gap and the real exchange rate. Finally, flexible inflation targeting outperforms strict inflation targeting in terms of welfare.

Subject: Exchange rate flexibility, Exchange rates, Foreign exchange, Inflation, Inflation targeting, Managed exchange rates, Monetary policy, Prices

Keywords: Commodity price inflation, CPI inflation targeting, Exchange rate, Exchange rate flexibility, Exchange rate rule, Exchange rates, Flexible CPI inflation targeting, Global, Inflation, Inflation index, Inflation indicator, Inflation stability, Inflation targeting, Inflation targeting index, Inflation volatility, Interest rate shock, Managed exchange rate case, Managed exchange rates, Monetary policy, Monetary policy rules, Open economy, Policy rule, Southeast Asia, WP

Publication Details

Pages:

37
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2004/021
Stock No:

WPIEA0212004
ISBN:

9781451921892
ISSN:

1018-5941

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