Incorporating Financial Stability in Inflation Targeting Frameworks

Burcu Aydin and Engin Volkan

No 2011/224, IMF Working Papers from International Monetary Fund

Abstract: The global financial crisis has exposed the limitations of a conventional inflation targeting (IT) framework in insulating an economy from shocks, and demonstrated that its rigid application may aggravate the effect of shocks on output and inflation. Accordingly, we investigate possible refinements to the IT framework by incorporating financial stability considerations. We propose a small open economy DSGE model, calibrated for Korea during the period of 2003 - 07, with real and financial frictions. The findings indicate that incorporating financial stability considerations can help smooth business cycle fluctuations more effectively than a conventional IT framework.

Keywords: WP; inflation targeting; central bank; risk premium; DSGE; financial accelerator; monetary policy; financial stability; IT framework; ITFS rule; demand shock; interest rate rule; inflation-targeting policy; depreciation rate; reaction function; inflation targeting rule; base interest rate; investment goods; capital utilization rate; country risk risk premium; Financial sector stability; Return on investment; Housing; Self-employment; Consumption; Global (search for similar items in EconPapers)
Pages: 45
Date: 2011-09-01
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Citations: View citations in EconPapers (16)

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