Inflation Targeting and Exchange Rate Management In Less Developed Countries
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Summary:
We analyze 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. Our 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.
Series:
Working Paper No. 2016/055
Subject:
Currencies Exchange rate flexibility Exchange rates Foreign exchange Inflation Money Prices Real exchange rates
English
Publication Date:
March 8, 2016
ISBN/ISSN:
9781513567433/1018-5941
Stock No:
WPIEA2016055
Pages:
65
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