Designing Monetary Policy for Developed and Developing Countries
Lead Research Organisation:
London School of Economics and Political Science
Department Name: Economics
Abstract
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| Description | The main goal of this research is to study certain aspects of the conduct of monetary policy in in developed and developing countries. We examined this along three dimensions. In the first strand we address the issue of credible institutions, which is particularly relevant for developing countries that aim at adopting an inflation targeting regime. In the second strand, we abstract from credibility issues and analyze how concerns about fiscal stabilization affect the performance and the optimality of inflation targeting. The third strand revisits the foundation of the monetary transmission mechanism by studying the evidence of wage setting practices. This will be critical to understand how inflation targeting operates in practice and interacts with fiscal policy. We find that when inflation target is not fully credible to the private sector, the learning process of both private agents and the central bank generates high persistence and volatility of inflation even though the underlying shocks to the economy are purely transitory. We also find that the persistence and volatility become smaller as the inflation target becomes more credible. In studying the role of fiscal policy in an open economy context, we find that differently, from the closed economy framework in an open economy it is not optimal to perfectly smooth taxes and fiscal policy should be conducted in a countercyclical way (i.e. following a positive technological shock, income taxes should increase). In studying the transmission mechanism of monetary policy, we show that the effectiveness of monetary policy is strictly linked to the timing in which policy actions are undertaken: indeed large effects on output and employment are observed when wages are relatively rigid, and none or insignificant effects are when wages are relatively more flexible. So that monetary policy is more effective when wages have just been agreed or set rather than before the wage-setting process. |
| Exploitation Route | International institutions and central banks should be interested in the outcome in this research. In terms of shaping credibility of domestic policy institutions, re-emphasize the role of fiscal policy as a stabilization policy tool and in understanding the transmission mechanism of monetary policy |
| Sectors | Education |
| Description | There is some evidence on the acknowledgment of our findings based on citations of the output produced in this research and also on the interests expressed by conference organizers in international institutions in inviting papers belonging to this research project. Two of the three papers that have been submitted to this research proposal are now published in peer-reviewed journals (JME and JMCB) |
| Sector | Education |
| Impact Types | Economic |