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Inflation Targeting, Exchange Rate and Financial Globalization

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  • Muhammad Naveed Tahir

    (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure de Lyon)

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    Abstract

    In this paper we investigate the impact of financial globalization on the behaviour of inflation targeting emerging market economies with respect to exchange rate - do central banks respond to exchange rate movements or not. We use quarterly data for six emerging market inflation targeting economies from the date of their inflation targeting adoption to 2009 Q4. The study uses small open economy new Keynesian model à la Gali and Monacelli (2005), and employs multi-equation GMM technique to investigate the relationship. We find that the response of central bank to the exchange rate in case of Brazil, Chile, Mexico and Thailand is statistically significant while insignificant for Korea and Czech Republic. Theoretically, it should not be so as even under flexible inflation targeting central bank responds to inflation deviation and output gap; we think that the peculiar characteristics of emerging markets, like fear of floating, weak financial system and low level of central bank credibility make exchange rate important for these economies.

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    Bibliographic Info

    Paper provided by HAL in its series Working Papers with number halshs-00646601.

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    Date of creation: 30 Nov 2011
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    Handle: RePEc:hal:wpaper:halshs-00646601

    Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00646601/en/
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    Related research

    Keywords: Inflation Targeting; Exchange Rate; Emerging Markets;

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    1. Neiss, Katharine & Nelson, Edward, 2001. "The Real Interest rate Gap as an Inflation Indicator," CEPR Discussion Papers 2848, C.E.P.R. Discussion Papers.
    2. André Minella & Paulo Springer de Freitas & Ilan Goldfajn & Marcelo Kfoury Muinhos, 2003. "Inflation targeting in Brazil: lessons and challenges," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy in a changing environment, volume 19, pages 106-133 Bank for International Settlements.
    3. Nicoletta Batini & Richard Harrison & Stephen P. Millard, 2001. "Monetary policy rules for an open economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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    5. Eric Parrado, 2004. "Inflation Targeting and Exchange Rate Rules in an Open Economy," IMF Working Papers 04/21, International Monetary Fund.
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    9. Chadha, Jagjit S & Dimsdale, Nicholas H, 1999. "A Long View of Real Rates," Oxford Review of Economic Policy, Oxford University Press, vol. 15(2), pages 17-45, Summer.
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    11. Klaus Schmidt-Hebbel & Alejandro Werner, 2002. "Inflation Targeting in Brazil, Chile, and Mexico: Performance, Credibility, and the Exchange Rate," Working Papers Central Bank of Chile 171, Central Bank of Chile.
    12. Scharler, Johann & Kaufmann, Sylvia, 2010. "Bank-Lending Standards, the Cost Channel and Inflation Dynamics," Working Papers 164, Oesterreichische Nationalbank (Austrian Central Bank).
    13. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," Working Papers 97-32, C.V. Starr Center for Applied Economics, New York University.
    14. Aurelien Eyquen & Güneş Kamber, 2010. "Internationalised Production in a Small Open Economy," Reserve Bank of New Zealand Discussion Paper Series DP2010/03, Reserve Bank of New Zealand.
    15. Gallant, A. Ronald & Tauchen, George, 1996. "Which Moments to Match?," Econometric Theory, Cambridge University Press, vol. 12(04), pages 657-681, October.
    16. M. S. Mohanty & Marc Klau, 2004. "Monetary policy rules in emerging market economies: issues and evidence," BIS Working Papers 149, Bank for International Settlements.
    17. Eric Jondeau & Hervé Le Bihan, 2001. "Testing for a Forward-Looking Phillips Curve. Additional Evidence from European and US data," Macroeconomics 0111005, EconWPA.
    18. Schmidt-Hebbel, Klaus & Tapia, Matias, 2002. "Inflation targeting in Chile," The North American Journal of Economics and Finance, Elsevier, vol. 13(2), pages 125-146, August.
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