Exchange Rate Regimes and Economic Stability of Emerging Economies:The Role of Inflation Targeting

The potential growth rates of emerging economies are much larger than those of developed economies. However, many emerging economies have vulnerable economic fundamentals and have frequently experienced severe economic crises in the past. As a result, making their local currencies credible and realizing sustainable growth have been significant priorities for many emerging economies. This paper analyzes what impacts the choice of the exchange rate regime had on macroeconomic performance of emerging economies using the panel data from the second half of the 2000s. In the analysis, we focus not only on the effects of traditional exchange rate regimes such as the floating and fixed exchange rate regimes, but also on those of inflation targeting and anchored exchange rate regimes. We explore their effects on the three macroeconomic performance indicators: economic growth rate, exchange rate depreciation, and inflation rate. The analysis revealed that the fixed exchange rate and anchored exchange rate regimes mitigated the exchange rate depreciation and the inflation rate but decreased economic growth in emerging economies. On the other hand, the inflation targeting regime not only sustained economic growth as the floating exchange rate regime did, but also mitigated the exchange rate depreciation and the inflation rate as the fixed exchange rate regime did. This result shows that emerging economies adopting the inflation targeting could achieve high economic growth by maintaining flexibility in monetary policy as countries with floating exchange rates did. At the same time, they could achieve a stable inflation rate as countries with fixed exchange rates did. However, if we were to look at the short-run effects of introducing the inflation targeting, the results suggested that although the inflation targeting was effective in promoting growth, it was not effective in controlling inflation rates. Additionally, while the inflation targeting regime could stabilize short-term volatility of growth rates to some extent, no significant effects were observed in stabilizing exchange rate and inflation rate volatilities.