Inflation targeting or fear of floating in disguise? A broader perspective

Inflation and exchange rate pass-through

“…Monetary authorities in EMDEs have long been worried that significant exchange rate fluctuations could jeopardize price stability and force disruptive monetary policy responses. To alleviate these concerns, some countries adopted managed currency arrangements or leaned against undesirable currency movements with aggressive policy changes-a practice that has been dubbed "fear of floating" (Calvo and Reinhart 2002;Ball and Reyes 2008). However, a lack of exchange rate flexibility can amplify global shocks, encourage speculative attacks, and make it more difficult to anchor inflation expectations credibly.…”

“…In particular, monetary authorities might look beyond a shift in price levels but may choose to respond if the impact on inflation is persistent. The risk of policy missteps if the exchange rate pass-through to inflation is not properly evaluated is particularly elevated in emerging market and developing economies (EMDEs), where large currency movements are more frequent and central banks have a greater propensity to respond to them (Calvo and Reinhart 2002;Ball and Reyes 2008). This highlights the importance of correctly assessing the exchange rate pass-through ratio (ERPTR)-defined in this paper as the percentage increase in consumer prices associated with a 1 percent depreciation of the effective exchange rate after one year.…”

The nexus between the fear of floating and expenditures witching external adjustment mechanism: emerging European and Latin American floaters

“…By constructing an ER flexibility index, the authors found that the variability in international reserves and interest rates is high relative to ER variations suggesting that the authorities are attempting to stabilize the ER through both direct intervention in the foreign exchange market and open market operations. Variabilities of ER, interest rates and foreign exchange reserves are also analyzed in Ball and Reyes (2008), who tried to expand the findings of Calvo and Reinhart (2002) in order to distinguish between FOF, IT and ER targeting. Mishkin (2004) claims that mitigating ER fluctuations is related to interest rate policy (indirect influence to the ER), while ER manipulation is linked with foreign exchange reserves (direct influence to the ER).…”

Fear of Floating in Turkey

“…Because a country may respond to exchange rate fluctuations for reasons of inflation under the IT regime, these interventions should not be considered as a fear of floating at any time. As a result, a country adopting IT may appear to be fear of floater as argued by Agenor (2002), Reyes (2004 and2008), Eichengreen (2004), Fischer (2001), Mishkin (2004) and Reyes (2007). Nevertheless, Reyes (2004 and2008) argued that the IT regime is classified as a flexible exchange rate regime, so it requires changes occasionally in the interest rate for exchange rate reasons.…”

“…Otherwise, in the presence of a low ERPT, to understand whether the central banks exhibit the fear of floating is not difficult under an IT regime, and the interventions of central banks in the exchange rate may be interpreted as fear of floating. Ball and Reyes (2008) emphasize that the basic Taylor rule for a strict IT regime must be modified for an open economy to explain the relationship between the ERPT and the central bank's reaction to exchange rate movements because pass-through from exchange rate movements to traded goods prices creates an ineluctable relationship between inflation and exchange rates. However, in order to explain relationship between the ERPT and central bank reaction to exchange rate movements, we modify the central bank's reaction function following Ball and Reyes (2004), Reyes (2007) and Nogueira and Leon-Ledesma (2009).…”