Great Ratios and Inflation Targeting: Small Open Versus Small Semiopen Economies

Abstract

This chapter, by virtue of a generalized specification, examines the equilibrium growth paths under two distinct scenarios, namely, a small open economy and a small semiopen economy in a two-sector, endogenous growth model of money. We show that these two scenarios end up with very different characteristics of equilibrium and the steady-state effects of inflation targeting (IT). In a small open economy, there is a nonbalanced-growth path equilibrium (hence, great ratios are nonstationary), while in a small semiopen economy there is a balanced-growth path equilibrium (great ratios are stationary). This provides a convincing reconciliation of the discrepancy in the empirical literature on great ratios. In addition, our steady-state analysis implicitly suggests that a lower inflation target gives rise to a positive GDP growth effect only for those IT countries which are more open to international trade. This enables us to explain why IT countries are relatively open to the international market and why some IT countries with a high degree of trade openness continuously lowered their inflation targets in the 1990s.

Citation

Chang, W.-Y., Tsai, H.-F. and Chang, J.-J. (2023), "Great Ratios and Inflation Targeting: Small Open Versus Small Semiopen Economies", Lee, C.-F. and Yu, M.-T. (Ed.) Advances in Pacific Basin Business, Economics and Finance (Advances in Pacific Basin Business, Economics and Finance, Vol. 11), Emerald Publishing Limited, Leeds, pp. 27-40. https://doi.org/10.1108/S2514-465020230000011002