Working Paper: NBER ID: w9599
Authors: Ricardo J. Caballero; Arvind Krishnamurthy
Abstract: Emerging economies experience sudden stops in capital inflows. As we have argued in Caballero and Krishnamurthy (2002), having access to monetary policy during these sudden stops is useful, but mostly for insurance' rather than for aggregate demand reasons. In this environment, a central bank that cannot commit to monetary policy choices will ignore the insurance aspect and follow a procyclical rather than the optimal countercyclical monetary policy. The central bank will also intervene excessively to support the exchange rate. These inefficiencies are exacerbated by the presence of an expansionary bias. In order to solve these problems, we propose modifying the central bank's objective to (i) include state-contingent inflation targets, (ii) target a measure of inflation that overweights non-tradable inflation
Keywords: inflation targeting; sudden stops; capital inflows
JEL Codes: E60; E40; E50; F00; F30; F40; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy access (E52) | Insurance benefits (G52) |
| Lack of commitment to monetary policy (E49) | Procyclical monetary policy (E52) |
| Procyclical monetary policy (E52) | Inefficiencies (D61) |
| Excessive central bank intervention (E58) | Inefficiencies (D61) |
| Expansionary bias in policy framework (E62) | Inefficiencies (D61) |
| Modifications to central bank's objectives (E52) | More effective monetary policy framework (E63) |