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INFLATION TARGETING, PATTERN OF TRADE, AND ECONOMIC DYNAMICS

Published online by Cambridge University Press:  23 May 2018

Juin-jen Chang ,
Wen-ya Chang ,
Hsueh-fang Tsai  and
Ping Wang
Juin-jen Chang
Affiliation:
Academia Sinica
Wen-ya Chang
Affiliation:
Fu-Jen Catholic University
Hsueh-fang Tsai
Affiliation:
Fu-Jen Catholic University
Ping Wang*
Affiliation:
Washington University in St. Louis, Federal Reserve Bank of St. Louis, and NBER
*
Address correspondence to: Ping Wang, Department of Economics, Washington University in St. Louis, Campus Box 1208, One Brookings Drive, St. Louis, MO 63130, USA; e-mail: [email protected].
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Abstract

This paper develops an analytically tractable, two-country, two-traded-good dynamic general-equilibrium model of money to examine the long-run and short-run effects of a temporary change in the domestic inflation target on the trade pattern, the terms of trade, the foreign exchange rate, and the capital accumulation of each country and of the world economy. We find that such a temporary monetary innovation can generate permanent effects on the world distribution of capital and the pattern of trade, resulting in nonneutrality in an otherwise money-neutral cash-in-advance setting. This change also leads to very rich transitional dynamics that we fully characterize analytically. In particular, endogenous responses in transition can be monotone or nonmonotone and can exhibit over-shooting. Our analytic findings and quantitative results help explain some noticeable changes in the capital accumulation, output, and bilateral trade of several countries adopting inflation targeting. Since the permanent effects of a temporary change in the domestic inflation target on the pattern of international trade and the performance of the macroeconomy are driven by a new channel through the world distribution of capital, we add new insights to the literature.

Keywords

Inflation TargetingDynamic Pattern of TradeWorld Distribution of Capital
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 7 , October 2019 , pp. 2748 - 2786
Copyright
Copyright © Cambridge University Press 2018 

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Footnotes

We thank Been-Lon Chen, Mario Crucini, Ching-Chong Lai, Chang-Ching Lin, Hsieh-Yu Lin, Juan Pantano, B. Ravikumar, Ray Riezman, Steve Turnovsky, and Chong K. Yip for valuable comments and suggestions, three anonymous referees, as well as conference participants at the Econometric Society Summer Meetings, the Midwest Economic Theory and International Trade Meetings, the Midwest Macroeconomic Conference, the Society for the Advancement of Economic Theory Conference, and the Society for Economic Dynamics Meetings. Part of this paper was completed while the fourth author was visiting Academia Sinica and Fu-Jen Catholic University. We are saddened to acknowledge that the second author passed away unexpectedly in the process of this collaboration. The usual disclaimer applies.

References

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