Löffler, Axel Schnabl, Gunther Schobert, Franziska
Year of Publication:
CESifo working paper Monetary Policy and International Finance 3138
Given buoyant capital inflows and managed exchange rates the majority of emerging market central banks have continued to accumulate massive foreign reserves. If left unsterilized, the liquidity expansion can threaten domestic macroeconomic stability. To contain domestic inflation these central banks absorb rather then provide liquidity in their regular monetary policy operations. Based on an augmented Barro-Gordon framework we show that inflation targeting within an environment of surplus liquidity is less efficient, because absorbing liquidity raises the costs of monetary policy operations. By implementing sterilization costs into the central bank's objective function the inflation bias increases.
inflation targeting exchange rate targeting sterilization debtor central bank