IDEAS home Printed from https://ideas.repec.org/a/taf/jitecd/v13y2004i3p265-285.html
   My bibliography  Save this article

Exchange rate versus inflation targeting: a theory of output fluctuations in traded and non-traded sectors

Author

Listed:
  • Øistein Røisland
  • Ragnar Torvik

Abstract

This paper develops a basic model for output fluctuations in traded and non-traded sectors under two alternative monetary policy regimes; exchange rate targeting (or monetary union) and inflation targeting. The conventional wisdom from one-sector models says that inflation targeting gives better output stabilization than exchange rate targeting when demand shocks occur, but the opposite when supply shocks occur. In a model with a traded and a non-traded sector, we show that the conventional wisdom holds for the non-traded sector. However, for the traded sector, we show that inflation targeting destabilizes output compared with exchange rate targeting when both supply and demand shocks occur. The only shocks where inflation targeting provides the better output stability for the traded sector are shocks to world market prices. The two-sector structure introduces new mechanisms that may turn around earlier results for aggregate production. For instance, a demand shock may induce higher aggregate output fluctuations with inflation targeting than with exchange rate targeting. Furthermore, a positive demand shock may prove to be contractionary under inflation targeting.

Suggested Citation

  • Øistein Røisland & Ragnar Torvik, 2004. "Exchange rate versus inflation targeting: a theory of output fluctuations in traded and non-traded sectors," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 13(3), pages 265-285.
    • Handle: RePEc:taf:jitecd:v:13:y:2004:i:3:p:265-285
    DOI: 10.1080/0963819042000240020
    as

    Download full text from publisher

    File URL: http://www.tandfonline.com/doi/abs/10.1080/0963819042000240020
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1080/0963819042000240020?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
    2. Torvik, Ragnar, 2001. "Learning by doing and the Dutch disease," European Economic Review, Elsevier, vol. 45(2), pages 285-306, February.
    3. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    4. van Wijnbergen, Sweder J G, 1984. "The 'Dutch Disease': A Disease after All?," Economic Journal, Royal Economic Society, vol. 94(373), pages 41-55, March.
    5. repec:bla:scandj:v:91:y:1989:i:2:p:439-69 is not listed on IDEAS
    6. Laurence Ball, 2002. "Policy Rules and External Shocks," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 3, pages 047-064, Central Bank of Chile.
    7. Jacqueline Dwyer, 2003. "Nominal Wage Rigidity in Australia," Australian Journal of Labour Economics (AJLE), Bankwest Curtin Economics Centre (BCEC), Curtin Business School, vol. 6(1), pages 5-24, March.
    8. Dornbusch, Rudiger, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 141-153, February.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Boug, Pål & Brasch, Thomas von & Cappelen, Ådne & Hammersland, Roger & Hungnes, Håvard & Kolsrud, Dag & Skretting, Julia & Strøm, Birger & Vigtel, Trond C., 2023. "Fiscal policy, macroeconomic performance and industry structure in a small open economy," Journal of Macroeconomics, Elsevier, vol. 76(C).
    2. Dimitris Korobilis & Maximilian Schroder, 2023. "Monitoring multicountry macroeconomic risk," Papers 2305.09563, arXiv.org.
    3. Aivazian, Sergei & Stepanov, Vladimir & Kozlova, Maria, 2006. "Measuring the Synthetic Categories of Quality of Life in a Region and Identification of Main Trends to Improve the Social and Economic Policy (Samara Region and its Constituent Territories)," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 2(2), pages 18-84.
    4. Leitemo,K., 1999. "Inflation targeting strategies in small open economies," Memorandum 21/1999, Oslo University, Department of Economics.
    5. Libman, Emiliano, 2017. "Asymmetric Monetary and Exchange Rate Policies in Latin America," MPRA Paper 78864, University Library of Munich, Germany.
    6. Holden,S., 1999. "Wage setting under different monetary regimes," Memorandum 12/1999, Oslo University, Department of Economics.
    7. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2003. "Econometric inflation targeting," Econometrics Journal, Royal Economic Society, vol. 6(2), pages 430-461, December.
    8. Shulgin, Andrey, 2006. "The Russian Foreign Exchange Policy on the Wave of Crisis Cycle," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 4(4), pages 18-48.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Alberola, Enrique & Benigno, Gianluca, 2017. "Revisiting the commodity curse: A financial perspective," Journal of International Economics, Elsevier, vol. 108(S1), pages 87-106.
    2. Bergholt, Drago & Røisland, Øistein & Sveen, Tommy & Torvik, Ragnar, 2023. "Monetary policy when export revenues drop," Journal of International Money and Finance, Elsevier, vol. 137(C).
    3. Garcia, Carlos J. & Restrepo, Jorge E. & Roger, Scott, 2011. "How much should inflation targeters care about the exchange rate?," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1590-1617.
    4. Andrew Sharpe & Bert Waslander, 2014. "The Impact of the Oil Boom on Canada's Labour Productivity Performance," CSLS Research Reports 2014-05, Centre for the Study of Living Standards.
    5. LAL, Deepak & van Wijnbergen, Sweder, 1985. "Government deficits, the real interest rate and LDC debt : On global crowding out," European Economic Review, Elsevier, vol. 29(2), pages 157-191.
    6. Costantini, Valeria & Monni, Salvatore, 2008. "Environment, human development and economic growth," Ecological Economics, Elsevier, vol. 64(4), pages 867-880, February.
    7. Frederick Ploeg, 2011. "Fiscal policy and Dutch disease," International Economics and Economic Policy, Springer, vol. 8(2), pages 121-138, June.
    8. McKnight, Stephen & Mihailov, Alexander & Pompa Rangel, Antonio, 2020. "What do Latin American inflation targeters care about? A comparative Bayesian estimation of central bank preferences," Journal of Macroeconomics, Elsevier, vol. 63(C).
    9. Torstein Bye & Erling Holmϕy, 2010. "Removing Policy-based Comparative Advantage for Energy Intensive Production: Necessary Adjustments of the Real Exchange Rate and Industry Structure," The Energy Journal, , vol. 31(1), pages 177-198, January.
    10. Marco Airaudo & Luis-Felipe Zanna, 2004. "Endogenous Fluctuations in Open Economies: The Perils of Taylor Rules Revisited," Money Macro and Finance (MMF) Research Group Conference 2004 6, Money Macro and Finance Research Group.
    11. Sánchez, Marcelo, 2008. "Monetary stabilisation in a currency union of small open economies," Working Paper Series 927, European Central Bank.
    12. Vaz, Paulo Henrique, 2017. "Discovery of natural resources: A class of general equilibrium models," Energy Economics, Elsevier, vol. 61(C), pages 174-178.
    13. Javier Guillermo Gómez, 2006. "Capital Flows and Monetary Policy," Borradores de Economia 2097, Banco de la Republica.
    14. Santos, Carlos Filipe & Fuinhas, José Alberto & Marques, António Cardoso, 2014. "O nexus energia-crescimento e o nível da auto-suficiência na produção de petróleo: análise com macro painel [Energy-growth nexus and oil self-sufficiency: macro panel analysis]," MPRA Paper 57008, University Library of Munich, Germany.
    15. Kolstad, Ivar & Wiig, Arne, 2009. "It's the rents, stupid! The political economy of the resource curse," Energy Policy, Elsevier, vol. 37(12), pages 5317-5325, December.
    16. Fernando de Holanda Barbosa, 2011. "The natural rate of interest in a small open economy," Working Papers 0121, Universidade Federal do Paraná, Department of Economics.
    17. Bjørnland, Hilde C. & Thorsrud, Leif Anders & Torvik, Ragnar, 2019. "Dutch disease dynamics reconsidered," European Economic Review, Elsevier, vol. 119(C), pages 411-433.
    18. Nogueira, Veridiana de Andrade & Mori, Rogério & Marçal, Emerson Fernandes, 2013. "Transmissão da variação cambial para as taxas de inflação no Brasil: estimação do pass-through através de modelos de vetores autorregressivos estruturais com correção de erros," Textos para discussão 349, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).
    19. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 947-981, July.
    20. Hilde C. Bjørnland & Leif Anders Thorsrud, 2013. "Boom or gloom? Examining the Dutch disease in a two-speed economy," Working Papers No 6/2013, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:jitecd:v:13:y:2004:i:3:p:265-285. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Longhurst (email available below). General contact details of provider: http://www.tandfonline.com/RJTE20 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.