Revising Arguments for the Modern Policy Framework - an Empirical Study
Pursuing a low inflation policy in an environment of open capital accounts and flexible exchange rates is a basic strategy that is widely adopted by industrialized and emerging economies.The general appeal of this framework can be summarized by few basic arguments. Namely, the fact that so many economies aim to keep their inflation rates low and stable reflects the view that economic growth and stability can be achieved more easily in this environment. Openness of capital accounts is regarded as indispensable since it promises significant welfare gains from improved capital allocation. Lastly, policymakers prefer free floating exchange rates to alternative policies of imperfect flexibility to be better able to pursue a domestic monetary policy under globalized capital markets. While the empirical investigation of such claims has important implications for the most fundamental decisions of monetary policy, extant studies suffer from several conceptual shortcomings that might complicate straightforward conclusions. In this study the aforementioned claims are re-investigated from an empirical point of view, taking into account associated pitfalls in related research.