Inflation Targeting by Debtor Central Banks in Emerging Market Economies
36 Pages Posted: 31 Jul 2010
Date Written: July 29, 2010
Given buoyant capital inflows and managed exchange rates the majority of emerging market central banks have continued to accumulate massive foreign reserves. If left unsterilized, the liquidity expansion can threaten domestic macroeconomic stability. To contain domestic inflation these central banks absorb rather then provide liquidity in their regular monetary policy operations. Based on an augmented Barro-Gordon framework we show that inflation targeting within an environment of surplus liquidity is less efficient, because absorbing liquidity raises the costs of monetary policy operations. By implementing sterilization costs into the central bank’s objective function the inflation bias increases.
Keywords: inflation targeting, exchange rate targeting, sterilization, debtor central bank
JEL Classification: E52, E58
Suggested Citation: Suggested Citation