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Monetary policy in sudden stop-prone economies

Louphou Coulibaly ()

Cahiers de recherche from Universite de Montreal, Departement de sciences economiques

Abstract: In a model featuring sudden stops and pecuniary externalities, I show that the ability to use capital controls has radical implications for the conduct of monetary policy. Absent capital controls, following an inflation targeting regime is nearly optimal. However, if the central bank lacks commitment, it will follow a monetary policy that is excessively procyclical and not desirable from an ex ante welfare prospective: it increases overall indebtedness as well as the frequency of financial crisis and reduces social welfare relative to an inflation targeting regime. Access to capital controls can correct this monetary policy bias. With capital controls, relative to an inflation targeting regime, the time-consistent regime reduces both the frequency and magnitude of crises, and increases social welfare. This paper rationalizes the procyclicality of the monetary policy observed in many emerging market economies.

Keywords: Financial crises; monetary policy; capital controls; time consistency; aggregate demand externality; pecuniary externality (search for similar items in EconPapers)
JEL-codes: E44 E52 F38 F41 G01 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2018
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Downloads: (external link)
http://hdl.handle.net/1866/20649 (application/pdf)

Related works:
Working Paper: Monetary Policy in Sudden Stop-prone Economies (2019) Downloads
Working Paper: Monetary Policy in Sudden Stop-Prone Economies (2018) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:mtl:montde:2018-03

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