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Inflation Targeting in Dollarized Economies

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  • Leonardo Leiderman
  • Rodolfo Maino
  • Eric Parrado

Abstract

The shift to inflation targeting has contributed to the relatively low inflation observed in some emerging market economies although, as noted by many economists, the preconditions required for a successful implementation were not in place. The existence of managed exchange rate regimes, a narrow base of domestic nominal financial assets, the lack of market instruments to hedge exchange rate risks, together with fear of floating and dollarization, have been stressed as factors that might weaken the efficacy of monetary policy. By examining various aspects of monetary transmission and policy formulation in two highly dollarized economies (Peru and Bolivia) vis-Ã -vis two economies with low levels of dollarization (Chile and Colombia), we found that, while dollarization imposes differences in both the transmission capacity of monetary policy and its impact on real and financial sectors, it does not preclude the use of inflation targeting as a policy regime.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/157.

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Length: 20
Date of creation: 01 Jun 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/157

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Keywords: Inflation targeting; Dollarization; exchange rate; inflation; monetary policy; foreign exchange; real exchange rate; nominal exchange rate; foreign exchange market; exchange market intervention; exchange rate volatility; exchange rates; exchange rate fluctuations; exchange rate pass; bilateral exchange rate; real effective exchange rate; exchange rate depreciation; exchange rate shocks; effective exchange rate; exchange rate regimes; aggregate demand; real exchange rate volatility; inflationary pressures; monetary aggregate; exchange rate appreciation; exchange rate risks; rate of inflation; low inflation; real exchange rates; exchange rate depreciations; flexible exchange rates; inflation target; exchange risk; nominal exchange rate depreciation; competitive exchange rate; price level; inflation targeting framework; multilateral real exchange rate; actual inflation; exchange rate regime; increase in inflation; rising inflation; foreign exchange risk; exchange rate change; inflation rate; exchange rate variability; real exchange rate appreciation; exchange rate float; exchange rate adjustments; nominal interest rate;

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References

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  1. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers, Stockholm - International Economic Studies 638, Stockholm - International Economic Studies.
  2. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  3. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  4. Laurence Ball, 1998. "Policy Rules for Open Economies," RBA Research Discussion Papers, Reserve Bank of Australia rdp9806, Reserve Bank of Australia.
  5. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1750, C.E.P.R. Discussion Papers.
  6. Philippe AGHION & Philippe BACCHETTA & Abhijit BANERJEE, 1999. "A Simple Model of Monetary Policy and Currency Crises," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP), Université de Lausanne, Faculté des HEC, DEEP 9914, Université de Lausanne, Faculté des HEC, DEEP.
  7. Guillermo A. Calvo, 2001. "Capital markets and the exchange rate with special reference to the dollarization debate in Latin America," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 312-338.
  8. repec:nbr:nberwo:12876 is not listed on IDEAS
  9. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, Springer, vol. 6(4), pages 459-472, November.
  10. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
  11. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and Choice of Exchange Rate Regime," Research Department Publications, Inter-American Development Bank, Research Department 4170, Inter-American Development Bank, Research Department.
  12. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, Elsevier, vol. 59(2), pages 323-347, March.
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