Inflation Targeting and Exchange Rate Management In Less Developed Countries

The central finding of this study is that management of the exchange rate greatly enhances the efficacy of inflation targeting

From:
Department for International Development
Published
31 March 2018
Document Type:
Journal Article
Theme:
Economic Growth
Authors:
Airaudo, M, Buffie, E.F., Zanna, L.F.

Abstract

The authors analyse coordination of monetary and exchange rate policy in a two-sector model of a small open economy featuring imperfect substitution between domestic and foreign financial assets. The central finding is that management of the exchange rate greatly enhances the efficacy of inflation targeting. In a flexible exchange rate system, inflation targeting incurs a high risk of indeterminacy where macroeconomic fluctuations can be driven by self-fulfilling expectations. Moreover, small inflation shocks may escalate into much larger increases in inflation ex post. Both problems disappear when the central bank leans heavily against the wind in a managed float.

This work is part of the ‘Macroeconomics in Low-income countries’ programme

Citation

  • Marco Airaudo, Edward F Buffie, Luis-Felipe Zanna (2016) Inflation Targeting and Exchange Rate Management In Less Developed Countries. IMF Working Paper No. 16/55

  • Edward F. Buffie, M. Airaudo, Felipe Zanna, Inflation targeting and exchange rate management in less developed countries, Journal of International Money and Finance, Volume 81, 2018, Pages 159-184, https://doi.org/10.1016/j.jimonfin.2017.09.013

Published 31 March 2018
Contents