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Economic Papers Vol.6 No.1(1)

Economic Research Institute (Institute for Monetary & Economic Research(tel: 82-2-759-5407, 5421 fax: 82-2-759-5410)) 2003.07.14 2316

TITLE : [Economic Papers 6-1]
          Non-tradeable Sector and Inflation Targeting
AUTHOR : Kwanghee Nam
CONTACT : Institute for Monetary & Economic Research
             (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.