Fiscal Adjustment and Inflation Targeting in Less Developed Countries

Edward F. Buffie and Manoj Atolia ()

Journal of Money, Credit and Banking, 2016, vol. 48, issue 8, 1839-1875

Abstract: Inflation targeting may not be viable in less developed countries (LDCs) where policymakers rely too heavily on cuts in infrastructure investment to balance the budget. Using a mix of analytical and numerical methods, we demonstrate that the equilibrium ceases to be saddle point stable under active policy when infrastructure cuts account for 30–70% of fiscal adjustment and the return on infrastructure exceeds a comparatively low threshold value. The result is robust to the form of the Taylor rule, the degree of real wage flexibility, the initial level of debt, the choice of a balanced‐budget or debt‐targeting rule, and the q‐elasticity of private investment spending.

Date: 2016
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https://doi.org/10.1111/jmcb.12365

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:48:y:2016:i:8:p:1839-1875

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