TITLE : [Economic Papers 6-1]
and Inflation Targeting
AUTHOR : Kwanghee Nam
CONTACT : Institute for
Monetary & Economic
(tel: 82-2-759-5407, 5421 fax: 82-2-759-5410)
ATTACH : EP6-1-1.pdf
This paper examines the effects of inflation targeting policy in a
small-open economy, that of Korea. It develops a two-sector model with tradeable
and non-tradeable sectors, and compares the effects of aggregate inflation
targeting and non-tradeable inflation targeting.
The tradeable and
non-tradeable price index that the paper computes shows that non-tradeable
inflation dominated tradeable inflation in the 1990s before the currency crisis.
During 1998-1999, however, tradeable inflation dominated non-tradeable
inflation. Meanwhile, from 2000 non-tradeable inflation was dominant again. And
during 1986-2001 aggregate inflation was relatively sensitive to import price
movements while non-tradeable inflation was more influenced by excess demand and
unit labor costs.
From the model economy, it is found that
non-tradeable inflation targeting is superior to aggregate inflation targeting
in stabilizing non-tradeable inflation and output, but not in stabilizing
aggregate inflation. In response to domestic shocks, non-tradeable inflation
targeting exercises an active role in adjusting interest rates. But in response
to exchange shocks, non-tradeable inflation targeting is passive in controlling
interest rates while tolerating volatile exchange rate movements.