Monetary Policy in Disaster-Prone Developing Countries

IMF Working Papers, April 1, 2022

Source details

Authors: Alessandro Cantelmo, Nikos Fatouros, Giovanni Melina, Chris Papageorgiou
Published: April 1, 2022
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9798400204371.001

The paper analyzes monetary policy regimes in emerging and developing economies where climate-related natural disasters are major macroeconomic shocks.
A narrative analysis of IMF reports published around the occurrence of natural disasters documents:
- the impact on important macroeconomic variables, and
- monetary policy responses.
Where countries have at least some degree of monetary policy independence, they typically react by tightening the monetary policy stance.
In a sizable number of cases, monetary policy was accommodated.
A small open-economy New-Keynesian model with disaster shocks is used to evaluate welfare under alternative monetary policy rules.
Model results suggest that:
- Responding to inflation to an extent sufficient to keep inflation expectations anchored, while allowing temporary deviations from its target, is the welfare maximizing policy.
- Alternative regimes such as strict inflation targeting, exchange rate pegs, or Taylor rules explicitly responding to economic activity or the exchange rate would be welfare-detrimental.

Anchor inflation expectations by responding to inflation sufficiently, while tolerating temporary deviations from the inflation target when disasters occur.
Avoid policy regimes that mechanically impose:
- strict inflation targeting,
- exchange rate pegs, or
- Taylor-type rules that explicitly respond to economic activity or the exchange rate,

as these are indicated by the model to be welfare-detrimental in the presence of disaster shocks.

Approach:
- Narrative analysis of IMF reports around natural disasters to document macroeconomic impacts and policy responses.
- Quantitative evaluation using a small open-economy New-Keynesian model with disaster shocks.
Geographic and thematic focus:
- Emerging and developing economies experiencing climate-related natural disasters.
- Topics include Conventional peg, Environment, Foreign exchange, Inflation, Inflation targeting, Monetary policy, Monetary policy frameworks, Natural disasters, Prices.
Keywords used in the paper: analysis documentation, Caribbean, cases monetary policy, Climate Change, Conventional peg, DSGE, Exchange Rate Regimes., Inflation, Inflation targeting, inflation volatility, Monetary Policy, Monetary policy frameworks, monetary policy response, monetary policy stance, Natural disasters, Natural Disasters.