The Relationship Between Exchange Rates and Inflation Targeting Revisited

Abstract

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.

Exchange rates, price levels, and inflation targeting: Evidence from Asian countries

“…The most important implication of our results is that inflation targeting could be effective in stabilizing price levels and lowering inflation volatility through either of two channels: reduced exchange rate pass-through and exchange rate volatility. Portions of our results are consistent with evidence adduced by Edwards (2006).…”

“…There is, additionally, some evidence that the adoption of inflation targeting reduces exchange rate volatility in all countries, while reform in the direction of a floating regime has positively affected exchange rate variability. This is consistent with the results of various empirical studies, such as Edwards (2006) and Rose (2007), but it contrasts with Gali and Monacelli (2005). Interestingly, two very different effects on exchange rate volatility-one associated with a reform that involves a transition toward a floating regime and the other associated with a reform that involves inflation targeting under a floating regime-appear to cancel each other out.…”

“…It should be noted that there are two implications of incorporating the coefficients of ∆lnP t-1 . First, doing so enables us to assess whether a stronger anti-inflationary policy decreases inflationary inertia (Taylor, 2000) and it also furnishes another channel through which inflation targeting may lower long-run pass-through (Edwards, 2006).…”

“…The recent study by Edwards (2006), covering seven countries with some extensions to Chile, shows that inflation targeting does not result in an increase in exchange rate volatility and emphasizes that inflation targeting helps reduce unexpected shocks by making monetary policy transparent and predictable.…”

Taxa de câmbio real e crescimento econômico: uma comparação entre economias emergentes e desenvolvidas

“…Autores como Eichengreen (2004), Edwards (2006) e Bresser-Pereira (2007) têm advogado em favor da importância da taxa de câmbio para o processo de crescimento. da mesma forma, a discussão sobre o "medo de flutuar", inaugurada por Calvo e , deixa evidente a importância do comportamento da taxa de câmbio e de suas flutuações, particularmente em economias emergentes.…”