Monetary Policy in Emerging Markets: Taming the Cycle

Abstract

In contrast to advanced markets (AMs), procyclical monetary policy has been a problem for emerging markets (EMs), with macroeconomic policies amplifying economic upswings and deepening downturns. The stark difference in policy has not been subject to extensive study and this paper attempts to address the gap. Key findings, using a large sample of EMs over the past 50 years, are: (i) EMs have adopted increasingly countercyclical monetary policy over time, although large differences remain among EMs and policies became more procyclical during the recent crisis. (ii) Inflation targeting and better institutions have been key factors behind the move to countercyclicality. (iii) Only deep financial markets allow EMs with flexible exchange rate regimes turn countercyclical. (iv) More countercyclical policy is associated with far less volatile output. The economically meaningful impact of IT on monetary policy countercyclicality and output variability is another reason in its favor, over and above better inflation outcomes.

Keywords: Monetary policy, Emerging markets, Chile, Inflation targeting, Business cycles, Countercyclical Policy, inflation, real interest rates, real interest rate, nominal interest rates, terms of trade, real rates, real output, inflation target, monetary aggregate, terms of trade shocks, terms of trade shock, reduction in inflation, foreign exchange, monetary institutions, real exchange rates, inflation data, inflation growth, rational expectations, nominal interest rate, inflation deviation, lower inflation, macroeconomic stability, actual inflation

JEL Classification: E52, F41