Implications and Relevance
Edited by Phillip Arestis, Michelle Baddeley and John S.L. McCombie
Chapter 13: Monetary models and inflation targeting in emerging market economies
13. Monetary models and inﬂation targeting in emerging market economies Valpy FitzGerald 1. INTRODUCTION As Mankiw (2003) points out in a recent survey of monetary economics, while traditional approaches to monetary policy relied upon transmission to lower inﬂation through output (and employment) depression via the Phillips curve, this tradeoff seems to have been overcome in advanced economies through labour market reform, which has allowed low inﬂation and low inﬂation to co-exist.1 Modern scholars now reach a similar conclusion by a different route – that of independent and unpredictable monetary shocks. In a sense, the modern approach to monetary economics in emerging market economies is similar, although the shocks in question are those of international ﬁnancial markets on the open developing economy: the exchange rate is thus far more important than textbook monetary theory2 would allow. Moreover, the Phillips curve had never been a convincing model of inﬂation in developing economies due to the extent of disguised unemployment. None the less, the International Monetary Fund (IMF) strongly holds the view3 that central bank monetary discretion is inherently inﬂationary,4 and thus makes binding monetary rules a condition for ofﬁcial ﬁnancial assistance to emerging market governments. The ‘new monetary policy’ (NMP) is understood to include: a numerical and ofﬁcial inﬂation target; monetary policy exercised through interest rates; an independent central bank; and no other objectives of monetary policy (Arestis and Sawyer, 2003). The monetary policy rule that generates interest rate responses to inﬂationary...
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