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A NOTE ON OPENNESS AND INFLATION TARGETING: IMPLICATIONS FOR THE UNPLEASANT FISCAL ARITHMETIC

Published online by Cambridge University Press:  26 February 2013

Helder Ferreira de Mendonça  and
Igor da Silva Veiga
Helder Ferreira de Mendonça*
Affiliation:
Fluminense Federal University and National Council for Scientific and Technological Development (CNPq)
Igor da Silva Veiga
Affiliation:
Fluminense Federal University
*
Address correspondence to: Helder Ferreira de Mendonça, Rua Dr. Sodré, 59—Vila Suíça, Miguel Pereira, Rio de Janeiro 26900-000, Brazil; e-mail: [email protected].
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Abstract

Emerging economies that have adopted inflation targeting and that combine low credibility, high public debt, and a high interest rate suffer from a typical problem. Increases in the interest rate to reduce departures of inflation from the target imply that a higher primary surplus is required for stabilizing public debt/GDP ratio. This tricky situation is known as “unpleasant fiscal arithmetic” (UFA). This article develops a theoretical model showing how increased financial openness and capital account liberalization can mitigate UFA. Furthermore, empirical evidence from the Brazilian case through OLS, GMM, and GMM system methods is offered. The findings show that increases in capital mobility and financial openness work as a commitment technology, which contributes to the success of the inflation targeting and thus reduces the risk of UFA.

Keywords

Inflation TargetingFinancial OpennessUnpleasant Fiscal ArithmeticCredibility
Type
Notes
Information
Macroeconomic Dynamics , Volume 18 , Issue 5 , July 2014 , pp. 1187 - 1207
Copyright
Copyright © Cambridge University Press 2013 

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