The effects of capital market openness on exchange rate pass-through and welfare in an inflation-targeting small open economy
Sanchita Mukherjee ()
No 1018, Working Papers (Old Series) from Federal Reserve Bank of Cleveland
This paper analyzes the impact of capital market openness on exchange rate pass-through and subsequently on the social loss function in an inflation-targeting small open economy under a pure commitment policy. Applying the intuition behind the macroeconomic trilemma, the author examines whether a more open capital market in an inflation-targeting country improves the credibility of the central bank and consequently reduces exchange rate pass-through. First, the effect of capital openness on exchange rate pass-through is empirically examined using a new Keynesian Phillips curve. The empirical investigation reveals that limited capital openness leads to greater pass-through from the exchange rate to domestic inflation, which raises the marginal cost of deviation from the inflation target. This subsequently worsens the inflation output-gap trade-off and increases the social loss of the inflation targeting central bank under pure commitment. However, the calibration results suggest that the inflation output-gap trade-off improves and the social loss decreases even in the presence of larger exchange rate pass-through if the capital controls are effective at insulating the exchange rate from interest rate and risk-premia shocks.
Keywords: Monetary policy; Inflation targeting; Foreign exchange (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac, nep-mon and nep-opm
References: View complete reference list from CitEc
Citations: Track citations by RSS feed
Downloads: (external link)
https://www.clevelandfed.org/~/media/content/newsr ... nomy%20pdf.pdf?la=en Full text (application/pdf)
Working Paper: The effects of capital market openness on exchange rate pass-through and welfare in an inflation targeting small open economy (2011)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:fip:fedcwp:1018
Ordering information: This working paper can be ordered from
Access Statistics for this paper
More papers in Working Papers (Old Series) from Federal Reserve Bank of Cleveland Contact information at EDIRC.
Bibliographic data for series maintained by ().