LIMITED ASSET MARKET PARTICIPATION AND DETERMINACY IN THE OPEN ECONOMY

Abstract

The perception that inflation targeting (IT) runs a high risk of indeterminacy when a significant share of households are too poor to save is an artifact of the closed economy. In the open economy, the Taylor principle is generally valid for both contemporaneous and forward-looking IT. Active policy in contemporaneous IT guarantees determinacy, eccentric cases aside. In forward-looking IT, the scope for active policy is constrained by an upper bound on the Taylor coefficient. The upper bound is insensitive, however, to the share of poor, nonsaving households. Moreover, it can be increased substantially–to a level that does not bind–through reserve sales/purchases that limit exchange rate volatility.