Inflation Persistence and Exchange Rate Regime: Implications for dynamic adjustment to shocks in a small open economy

Karlygash Kuralbayeva

No 63, OxCarre Working Papers from Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford

Abstract: The paper examines implications of ination persistence for business cycle dynamics following terms of trade shock in a small oil producing economy, under ination targeting and exchange rate targeting regimes. It is shown that due to the `Walters critique' effect, the country's adjustment paths are slow and cyclical if there is a signi cant backward-looking element in the inflation dynamics and the exchange rate is fixed. It is also shown that such cyclical adjustment paths are moderated if there is a high proportion of forward-looking price setters in the economy, so that when the Phillips curve becomes completely forward-looking cyclicality in adjustment paths disappears and the response of the real exchange rate becomes hump-shaped. In contrast, with an independent monetary policy, irrespective of the degree of inflation persistence, flexible exchange rate allows to escape severe cycles, which results in a smooth response of the real exchange rate.

Keywords: inflation inertia; inflation targeting; exchange ratge targeting; Phillips curve; oil shocks; small open economy (search for similar items in EconPapers)
JEL-codes: E32 F40 F41 (search for similar items in EconPapers)
Date: 2011-11-29
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Journal Article: Inflation persistence and exchange rate regime: Implications for dynamic adjustment to shocks in a small open economy (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:oxf:oxcrwp:063

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