Optimal Monetary Policy in Inflation Targeting Open Economies

Abstract

This paper presents a simple framework for analysing the operation and effectiveness of monetary policy in open economies in the spirit of aggregative approaches that are the mainstay of intermediate macroeconomic theory. Combining standard macroeconomic relations with precepts from international finance, it provides new lessons for the conduct of monetary policy under inflation targeting. It first confirms the classic Mundell-Fleming result that monetary policy is only effective as a short run stabilization instrument under floating exchange rates, yet goes further in showing that countercyclical monetary policy is incompatible with inflation targeting under fixed exchange rates. Second, it highlights the importance of anchoring inflation expectations as a means of inflation control. Third, it suggests how central banks should react to changes in the monetary stance abroad. Lastly, it demonstrates how monetary policy should respond to productivity improvement at home under floating exchange rates. (J.E.L.: E5, F41).

Investigation of optimal inflation targets for 15 major oil exporting Sub-Saharan African countries

“…They also reported that inflation targeting promotes stability in financial sectors. A review from inflation targeting open economies, Makin (2019) revealed that appropriate policy on inward strategy for productivity enhancement tends to control the pressure of inflation and price level in the medium term. On the Brazilian economy, Díaz-Roldán et al (2019) affirmed that fiscal rules and fiscal discipline under inflation targeting regime help in controlling the inflationary environment in Brazil.…”