MONETARY MODELS AND INFLATION TARGETINGIN EMERGING MARKET ECONOMIES

This paper extends and modifies the Keynesian critique of inflation targetingwith reference to stabilisation policy in emerging market economies. The IMF‘basic monetary programming framework’ for developing countries usesgovernment borrowing and the exchange rate as policy instruments in order toachieve specific inflation and balance of payments targets. This paper firstadapts this standard model in order to include short-term capital flows and thefloating exchange rate arising from financial liberalisation. In this way, themacroeconomic consequences of the current Fund focus on inflation targetingand the use of a single monetary policy instrument (the interest rate, combinedwith rigid fiscal and reserve ‘rules’) in emerging market economies can bedemonstrated. Second, the paper encompasses the structuralist critique of thenegative effect of inflation targeting on capacity utilisation and tradecompetitiveness, leading to an argument for counter-cyclical monetary policyin response to external shocks. An alternative model is constructed within acomparable macroeconomic framework to that of the IMF in order to permitthe shortcomings of inflation targeting to be rigorously demonstrated. Amacroeconomic stabilisation policy based on real exchange rate targeting,bank credit regulation and an active fiscal stance is shown be more effective insupporting growth and investment....