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A model of inflation targeting in an open economy

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  • Jay H. Levin

    (Department of Economics, Wayne State University, USA)

Abstract

This paper develops a model of inflation targeting in a small open economy under floating exchange rates. The central bank follows a simple Taylor rule to achieve a target inflation rate, and the inflation process itself is determined by an expectations augmented Phillips curve mechanism. The behaviour of the exchange rate is governed by uncovered interest parity as a benchmark case, and both exchange rate expectations and inflationary expectations are assumed to be held with perfect foresight. Finally, the level of output in the economy varies gradually in response to excess demand in the goods sector. The paper analyses the effects of two shocks, a reduction in the central bank's target inflation rate and a sudden increase in aggregate demand. The effects of these shocks in a large country engaged in inflation targeting on the outside world follow from these results. Copyright © 2004 John Wiley & Sons, Ltd.

Suggested Citation

  • Jay H. Levin, 2004. "A model of inflation targeting in an open economy," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(4), pages 347-362.
    • Handle: RePEc:ijf:ijfiec:v:9:y:2004:i:4:p:347-362
    DOI: 10.1002/ijfe.243
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    References listed on IDEAS

    as
    1. Mishkin, Frederic S., 1998. "International Experiences With Different Monetary Policy Regimes," Seminar Papers 648, Stockholm University, Institute for International Economic Studies.
    2. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
    3. Brayton, Flint & Levin, Andrew & Lyon, Ralph & Williams, John C., 1997. "The evolution of macro models at the Federal Reserve Board," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 43-81, December.
    4. Laurence Ball, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
    5. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q II), pages 5-33.
    6. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    8. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
    9. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    10. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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    Cited by:

    1. H. Kent Baker & Satish Kumar & Kirti Goyal & Prashant Gupta, 2023. "International journal of finance and economics: A bibliometric overview," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(1), pages 9-46, January.

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