Inflation Targeting, Capital Mobility and Macroeconomic Stability

Meixing Dai () and Moise Sidiropoulos

MPRA Paper from University Library of Munich, Germany

Abstract: In this paper we examine the macroeconomic stability in a simple dynamic open economy model, in which monetary authorities adopt an flexible inflation-targeting regime in an environment with a liberalised capital account and flexible exchange rates. In this respect, inflation targeting is an essential part of a three-part policy (or trinity) that also includes flexible exchange rate and capital mobility. We show that a low degree of inflation targeting flexibility (i.e., central bank�s response is aggressive toward inflation) with a high degree of capital mobility implies a dynamically unstable solution in this simple rational expectations model. In contrast, when central bank adopts a high degree of inflation-targeting flexibility (accommodative central bank), stability can be ensured under any degree of capital mobility. Finally, under low degree of inflation targeting flexibility, it seems necessary to limit the degree of capital mobility in order to maintain stability in countries opening their economies to international capital flows, mainly in emerging market and transition economies.

Keywords: Inflation targeting; optimal monetary policy; capital account liberalisation (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 F32 F41 (search for similar items in EconPapers)
Date: 2003-07, Revised 2005-05
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:13858

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