Inflation Targeting and Sudden Stops

26 Pages Posted: 5 Apr 2003 Last revised: 25 Sep 2022

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Arvind Krishnamurthy

Northwestern University - Kellogg School of Management

Date Written: April 2003

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

Suggested Citation

Caballero, Ricardo J. and Krishnamurthy, Arvind, Inflation Targeting and Sudden Stops (April 2003). NBER Working Paper No. w9599, Available at SSRN: https://ssrn.com/abstract=392986

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Arvind Krishnamurthy

Northwestern University - Kellogg School of Management ( email )

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