The Role of the Exchange Rate in Inflation-Targeting Emerging Economies

Business & Finance, Economics, Public Finance, Finance & Investing, Banks & Banking, Macroeconomics
Cover of the book The Role of the Exchange Rate in Inflation-Targeting Emerging Economies by Anna Nordstrom, Scott Mr. Roger, Mark Mr. Stone, Seiichi Shimizu, Turgut Kisinbay, Jorge Restrepo, INTERNATIONAL MONETARY FUND
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Author: Anna Nordstrom, Scott Mr. Roger, Mark Mr. Stone, Seiichi Shimizu, Turgut Kisinbay, Jorge Restrepo ISBN: 9781452726113
Publisher: INTERNATIONAL MONETARY FUND Publication: November 23, 2009
Imprint: INTERNATIONAL MONETARY FUND Language: English
Author: Anna Nordstrom, Scott Mr. Roger, Mark Mr. Stone, Seiichi Shimizu, Turgut Kisinbay, Jorge Restrepo
ISBN: 9781452726113
Publisher: INTERNATIONAL MONETARY FUND
Publication: November 23, 2009
Imprint: INTERNATIONAL MONETARY FUND
Language: English

This paper explores the role of exchange rates in emerging economies with inflation-targeting regimes, an issue that has become especially germane during the current episode of financial turmoil and volatile capital flows. Under inflation targeting, the interest rate is the main monetary policy tool for influencing activity and inflation, and there is little agreement about the appropriate role of the exchange rate.The exchange rate is a more important monetary policy tool for emerging economies that have adopted inflation targeting than it is for inflation-targeting advanced economies. Inflation-targeting emerging economies generally have less flexible exchange rate arrangements and intervene more frequently in the foreign exchange market than their advanced economy counterparts. The enhanced role of the exchange rate reflects these economies' greater vulnerability to exchange rate shocks and their less developed financial markets. However, their sharper focus on the exchange rate may cause some confusion about the commitment of their central banks to achieve the inflation target and may also complicate policy implementation. Global inflation pressures, greater exchange rate volatility, and the financial stresses from the global financial turmoil that began in mid-2007 are heightening these tensions.

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This paper explores the role of exchange rates in emerging economies with inflation-targeting regimes, an issue that has become especially germane during the current episode of financial turmoil and volatile capital flows. Under inflation targeting, the interest rate is the main monetary policy tool for influencing activity and inflation, and there is little agreement about the appropriate role of the exchange rate.The exchange rate is a more important monetary policy tool for emerging economies that have adopted inflation targeting than it is for inflation-targeting advanced economies. Inflation-targeting emerging economies generally have less flexible exchange rate arrangements and intervene more frequently in the foreign exchange market than their advanced economy counterparts. The enhanced role of the exchange rate reflects these economies' greater vulnerability to exchange rate shocks and their less developed financial markets. However, their sharper focus on the exchange rate may cause some confusion about the commitment of their central banks to achieve the inflation target and may also complicate policy implementation. Global inflation pressures, greater exchange rate volatility, and the financial stresses from the global financial turmoil that began in mid-2007 are heightening these tensions.

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