Flexible inflation targets, forex interventions and exchange rate volatility in emerging countries (original) (raw)

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

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.

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.

Inflation targeting in emerging economies: Panel evidence

Journal of Development Economics, 2010

This paper shows there is no evidence that the inflation targeting regime (IT) improves economic performance as measured by the behavior of inflation and output growth in developing countries. The control of common time effects results in less negative and less significant IT impacts on inflation, inflation volatility and output growth volatility than previously found in the literature. Additionally, our analysis shows robust evidence of lower output growth during IT adoption. On balance, although lower long-run mean inflation signals that the central banks of emerging economies with inflation targeting are more inflation-averse, the costs of disinflation have not been lower than under other monetary regimes. (B. Bystedt). 1 Postal address: 3 passage Jean Nicot, 75007 Paris, France. 2 list five fundamental institutional weaknesses common to emerging countries: (i) weak fiscal institutions; (ii) weak financial institutions, including government prudential regulation and supervision; (iii) low credibility of monetary institutions; (iv) currency substitution and liability dollarization; and (v) vulnerability to sudden stops of capital inflows. 0304-3878/$see front matter

Does inflation targeting lead to excessive exchange rate volatility?

2009

This paper analysis whether the adoption of in ‡ation targeting a¤ects excessive exchange rate volatility, i.e. the share of exchange rate ‡uctuations not related to economic fundamentals. Using a signal-extraction approach to estimate this excessive volatility in multivariate exchange rates in a sample of forty-four countries, the empirical results show no systematic relationship between in ‡ation targeting and excessive exchange rate volatility. Joint analysis of the e¤ects of in ‡ation targeting and EMU membership shows, however, that a membership in the monetary union signi…cantly reduces this excessive volatility. Together, the results suggest that ‡oating exchange rates not only serve as a shock absorber but are also an independent source of shocks, and that these excessive ‡uctuations in exchange rates can be reduced by joining a monetary union. At the same time the results suggest that adopting in ‡ation targeting does not by itself contribute to excessive exchange rate volatility.

Exchange-rate variations and the rate of inflation in emerging economies

CEPAL Review, 2016

This paper develops a structural general equilibrium model to analyse the reactions of the nominal exchange rate and the domestic price level to three types of external shock in emerging economies that have limited access to world capital markets. Although the results depend crucially on the type of external shock, each of the two national balance-sheet parameters considered here-the risk premium and the ratio of external indebtedness-exacerbates the reactions of the two endogenous variables without altering the degree of exchange-rate pass-through (erpt). Moreover, flatter Phillips curves, as observed today in many economies, tend to increase erpt. On the basis of these results, the authorities of emerging economies seeking to stabilize markets and limit erpt are advised to minimize the two risk parameters by applying a flexible inflation-targeting regime.

Important Elements for Inflation Targeting for Emerging Economies

IMF Working Papers, 2010

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This is the fifth chapter of a forthcoming monograph entitled "On Implementing Full-Fledged Inflation-Targeting Regimes: Saying What You Do and Doing What You Say." It examines whether certain conditions have to be met before emerging economies can adopt an inflation-targeting regime and provides some empirical evidence on the matter. The issues analyzed are the priority of inflation targeting over other goals, the absence of fiscal dominance, central bank independence, the degree of control over the policy interest rate, a sound methodology for forecasting, and the soundness of financial institutions and markets, and resilience to changes in exchange rates and interest rates.

Inflation targeting in emerging economies: What do the data say

2005

In a recent thought-provoking paper, Ball and Sheridan . Does inflation targeting matter? In: Bernanke, B.S., Woodford, M. (Eds.), The Inflation-Targeting Debate, University of Chicago Press] show that the available evidence for a group of developed economies does not lend credence to the belief that adopting an inflation targeting regime (IT) was instrumental in bringing inflation and inflation volatility down. Here, we extend Ball and Sheridan's analysis for a subset of 36 emerging market economies and find that, for them, the story is quite different. Compared to non-targeters, developing countries adopting the IT regime not only experienced greater drops in inflation, but also in growth volatility, thus corroborating the view that the regime's "constrained flexibility" to deal with adverse shocks delivered concrete welfare gains.