Inflation-targeting systems and exchange rates: the role of global financial variables in emerging economies

In this article the authors seek to determine whether global financial shifts are more costly for emerging economies that have adopted an inflation-targeting system than they are for countries that have no such system in place. The countries’ exchange rates and the volatility of those rates are used as yardsticks for measuring these costs. The authors’ findings indicate that, if a country adopts an inflation-targeting system and witnesses an increase in foreign capital inflows, it may experience a greater currency depreciation and less exchange rate volatility than a country without such a system. When the world interest rate rises, however, emerging economies with inflation-targeting systems experience greater exchange rate volatility than their counterparts that have no targeting system. In addition, the adoption of an inflation-targeting system by an emerging economy may result in a reduction in the exchange rate pass-through to domestic prices.