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LIMITED ASSET MARKET PARTICIPATION AND DETERMINACY IN THE OPEN ECONOMY

Published online by Cambridge University Press:  03 July 2017

Edward F. Buffie  and
Luis-Felipe Zanna
Edward F. Buffie*
Affiliation:
Indiana University
Luis-Felipe Zanna
Affiliation:
International Monetary Fund
*
Address correspondence to: Edward F. Buffie, Indiana University, 2414 East Rock Creek Drive, Bloomington, IN 47401, USA; e-mail: [email protected].
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Abstract

The perception that inflation targeting (IT) runs a high risk of indeterminacy when a significant share of households are too poor to save is an artifact of the closed economy. In the open economy, the Taylor principle is generally valid for both contemporaneous and forward-looking IT. Active policy in contemporaneous IT guarantees determinacy, eccentric cases aside. In forward-looking IT, the scope for active policy is constrained by an upper bound on the Taylor coefficient. The upper bound is insensitive, however, to the share of poor, nonsaving households. Moreover, it can be increased substantially–to a level that does not bind–through reserve sales/purchases that limit exchange rate volatility.

Keywords

Unflation TargetingExchange RateIndeterminacyAsset Market ParticipationTaylor Principle
Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Issue 8 , December 2018 , pp. 1937 - 1977
Copyright
Copyright © Cambridge University Press 2017 

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