Does inflation targeting lead to excessive exchange rate volatility? (original) (raw)

The Mix of Inflation Targeting and Exchange Rate Volatility: The Role of Exchange Rate Regimes

Ali Lamouchi, 2013

This paper tends to determine the possible effects on volatility of the real exchange rate due to the adoption of the policy of inflation targeting and to check if these effects vary according to announced and practiced exchange rate regimes. Using the method of two-step system-GMM with a panel of 62 countries covering the period 1987-2011, the results show that among the costs of the adoption of inflation targeting is the increase in the real volatility of the exchange rate. Moreover, we found that, for the two classifications De Jure and De Facto of the exchange rate regimes, the effect of inflation targeting on the volatility of exchange rate depends considerably on the type of exchange rate regime. We also concluded that, as in the developing countries, the Fear of Floating is also justified in the developed countries.

The Exchange Rate Dimension of Inflation Targeting: Target Levels and Currency Volatility

South African Journal of Economics, 2015

The surprising volatility of floating exchange rates have puzzled macroeconomists and challenged policy makers since the seventies. This is no less true in South Arica where the Rand's volatility is a longstanding policy and business challenge. This paper extends the literature on nominal and institutional factors associated with currency volatility. Rose's description of inflation as "Bretton Woods in reverse" is the departure point and is read with Berganza and Broto's recent demonstration in a time series study that inflation targeting emerging market economies have experience higher exchange rate volatility. Meanwhile Bleaney and Tian have shown the crosssectional connection between the level of inflation and exchange rate volatility. We build on Bleaney and Tian's cross-sectional approach to investigate the association between the level at which inflation targeting countries target inflation and exchange rate volatility over the long run. Crucially, we control for the average level of inflation and distinguish between inflation targeting countries that target high and low levels of inflation, in order to investigate whether the choice of the level of the inflation target (an institutional feature) is associated with greater exchange rate volatility. JEL Classification: F31, E58

The Relationship Between Exchange Rates and Inflation Targeting Revisited

2006

This paper deals with the relationship between inflation targeting and exchange rates. I address three specific issues: first, I analyze the effectiveness of nominal exchange rates as shock absorbers in countries with inflation targeting. This issue is closely related to the magnitude of the "pass-through" coefficient. Second, I investigate whether exchange rate volatility is different in countries with an inflation targeting regime than in countries with alternative monetary policy arrangements. And third, I discuss whether the exchange rate should play a role in determining the monetary policy stance under inflation targeting. An alternative way of posing this question is whether the exchange rate should have an independent role in an open economy Taylor rule.

Flexible inflation targets, forex interventions and exchange rate volatility in emerging countries

Journal of International Money and Finance, 2012

Emerging economies with infl ation targets (IT) face a dilemma between fulfi lling the theoretical conditions of "strict IT", which imply a fully fl exible exchange rate, or applying a "fl exible IT", which entails a de facto managed fl oating exchange rate with FX interventions to moderate exchange rate volatility. Using a panel data model for 37 countries we fi nd that, although IT lead to higher exchange rate instability than alternative regimes, FX interventions in some IT countries have been more effective to lower volatility than in non-IT countries, which may justify the use of "fl exible IT" by policymakers.

Patterns of Foreign Exchange Intervention under Inflation Targeting

IMF Working Papers

The paper documents the use of foreign exchange intervention (FXI) across countries and monetary regimes, with special attention to its use under inflation targeting (IT). We find significant differences between advanced and emerging market economies, with the former group conducting FXI limitedly and broadly symmetrically, while the use of this policy instrument in emerging market countries is pervasive and mostly asymmetric (biased towards purchasing foreign currency, even after taking into account precautionary motives). Within emerging markets, the use of FXI is common both under IT and non-IT regimes. We find no evidence of FXI being used in response to inflation developments, while there is strong evidence that FXI responds to exchange rates, indicating that IT central banks in EMDEs have dual inflation/exchange rate objectives. We also find a higher propensity to overshoot inflation targets in emerging market economies where FXI is more pervasive.

Inflation Targeting, Exchange Rate and Financial Globalization

2011

In this paper we investigate the impact of financial globalization on the behaviour of inflation targeting emerging market economies with respect to exchange rate – do central banks respond to exchange rate movements or not. We use quarterly data for six emerging market inflation targeting economies from the date of their inflation targeting adoption to 2009 Q4. The study uses

Inflation and Exchange Rate in : An Empirical Investigation

Critical Perspectives on Emerging Economies

One of the economic phenomena that affects every citizen, almost every day, is inflation (Reddy 1999). Monetary policy is considered to be an essential policy response for the control of inflation. One of the key elements of the Washington Consensus is that low and stable inflation is critical for market-driven growth and monetary policy is the most direct determinant of inflation (Bernanke et al. 1999). Monetary policy being the most flexible tool for achieving stabilization in the short run, has led central banks around the world to strive for developing strategies to control inflation and contribute to the stability and growth of the respective economies. Inflation targeting is one of those strategies which New Zealand pioneered, followed by Canada, the United Kingdom, and others. Currently, 41 countries (both developing and developed countries) following different exchange rate regimes have adopted the inflation targeting framework. The list of countries following inflation targeting regimes are presented in Appendix, Table 7.1). Inflation targeting is defined loosely as a monetary policy strategy characterized by public announcement of quantitative targets of inflation rate for a particular period, and by the explicit acknowledgment that price stability is the primary goal of monetary policy in the long run. The other features of the monetary policy framework are an instrument and operational independence, transparency in policymaking, and accountability of the monetary authority. These features are the critical components of the inflation targeting framework (Kamber et al. 2015; Walsh 2015). According to Bernanke et al. (1999), the inflation targeting framework serves two essential functions in an economy, i.e., (1) improving communication between policymakers and the public, and (2) the accountability and discipline in monetary