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Flexible Inflation Targeting, Real Exchange Rate and Structural Change in a Kaldorian Model with Balance of Payments Constrained Growth

José Luís Oreiro (), Luciano Dias de Carvalho (), Luciano Ferreira Gabriel () and Evaldo Henrique da Silva ()
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Luciano Dias de Carvalho: Federal University of Viçosa and University of Brasília, Brazil
Luciano Ferreira Gabriel: Federal University of Viçosa and University of Brasília, Brazil
Evaldo Henrique da Silva: Federal University of Viçosa and University of Brasília, Brazil

Ensayos Económicos, 2021, vol. 1, issue 78, 47-82

Abstract: The present article contributes to the literature of Kaldorian growth models with balance of payments constraint introducing some changes in the basic structure of Santana and Oreiro (2018) model. First, we will assume that monetary policy is conducted under a Flexible Inflation Targeting Regime where the goal of the monetary policy is not only to achieve a certain target for inflation; but also stabilize capacity utilization at its potential or target level. Second, we will assume that potential or target level of capacity utilization depends on the lagged value of this variable. This hypothesis captures the hysteresis effect of lower output growth over potential output, which is a phenomenon well documented in recent literature (Cerra, Fatás and Saxena, 2020). Finally, we will assume that inflation expectations depend on the credibility of the Central Bank. In the case where Central Bank is fully credible then inflation expectations are equal to the inflation target. Although the model was developed for a small open economy, it is designed for a mature economy in the sense of Lewis (1954): labor supply is inelastic and real output growth had to be equal to the natural growth rate in the long run. The natural growth rate is, however, endogenous because productivity growth depends both on output growth and employment rate. The natural growth rate adjusts itself to the actual growth rate of real output, determined by the balance of payments constraint, due to changes in the level of employment. In order for a balanced growth path to exist, it was also necessary to make the autonomous component of investment demand an endogenous variable in the long-run, as done by Lavoie (2016). In the long run equilibrium with structural change, it was shown that a decrease in the inflation target could increase the growth rate of real output, the capacity utilization, the rate of employment and the manufacturing share in GDP, becoming a driver of the process of structural change. Since monetary policy can affect the productive structure of the economy as well as the growth rate of real output and the rate of employment; then it is not possible to separate macroeconomics from economic development, which is core of the so-called structuralist development macroeconomics, the theoretical basis of the Brazilian NewDevelopmentalism School.

Keywords: balance of payments constrained growth; monetary policy; real exchange rate; structural change (search for similar items in EconPapers)
JEL-codes: E12 E44 E52 F41 F43 (search for similar items in EconPapers)
Date: 2021
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Handle: RePEc:bcr:ensayo:v:1:y:2021:i:78:p:47-82