Facing the Quadrilemma: Taylor rules, intervention policy and capital controls in large emerging markets

Abstract

This paper investigates extended Taylor rules and foreign exchange intervention functions in large Emerging Markets (EM), measuring the extent to which policies are designed to stabilize output, inflation, exchange rates and accumulate international reserves. We focus on two large emerging markets--India and Brazil. We also consider the impact of greater capital account openness and which rules dominate when policy conflicts arise. We find that output stabilization is a dominant characteristic of interest rate policy in India, as is inflation targeting in Brazil. Both countries actively use intervention policy to achieve exchange rate stabilization and, at times, stabilizing reserves around a target level tied to observable economic fundamentals. Large unpredicted intervention purchases (sales) accommodate low (high) interest rates, suggesting that external operations are subordinate to domestic policy objectives. We extend the work to Chile and China for purposes of comparison. Chile's policy functions are similar to Brazil, while China pursues policies that substantially diverge from other EMs.

State-level Taylor rule and monetary policy stress

“…The outcomes produced by integrating Taylor (or Taylor-type) rules into monetary policymaking, in terms of inflation stabilization and output growth, have been reasonably good (Orphanides, 2003;Caputo & Diaz, 2018;Chertman et al, 2020). When policy rates deviated from the ruleimplied level, for example, due to deliberate decisions to exert some desirable effects in financial markets or in other segments of an economy, the statutory targets related to inflation and output often had to be sacrificed to some extent.…”