 Inflation persistence and exchange rate regime: Implications for dynamic adjustment to shocks in a small open economyJournal of Macroeconomics, 2011, vol. 33, issue 2, 193-205 Abstract: The paper examines implications of inflation persistence for business cycle dynamics following terms of trade shock in a small oil producing economy, under inflation 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 significant 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; rate; targeting; Phillips; curve; Oil; shocks; Small; open; economy (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:33:y:2011:i:2:p:193-205 Access Statistics for this article Journal of Macroeconomics is currently edited by Douglas McMillin and Theodore Palivos More articles in Journal of Macroeconomics from Elsevier |
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