Small Open Economies with Frictions in Credit Markets: Target inflation or money growth when floating?

Paula Hernandez-Verme ()
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Paula Hernandez-Verme: Department of Economics and Finance, Universidad de Guanajuato

No EC200903, Department of Economics and Finance Working Papers from Universidad de Guanajuato, Department of Economics and Finance

Abstract: I compare the relative merits of a policy of inflation targeting for small open economies with frictions in financial markets with an alternative floating regime that has a constant rate of domestic money growth. The differences between these two policies appear only in the dynamic properties of equilibria with credit rationing. When the probability of loan repayment is low, inflation targeting eliminates endogenous volatility when compared with a constant money growth, but equilibria remain indeterminate. When the probability of loan repayment is high, inflation targeting always improves on the stability of equilibria, and sometimes it also eliminates endogenous fluctuations.

Keywords: Floating exchange rates; Inflation targeting; Multiple reserve requirements; Private Information; Stabilization; Endogenous volatility (search for similar items in EconPapers)
JEL-codes: E31 E32 E42 E44 F31 F33 G14 G18 O16 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2009-07
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