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The Nexus Between Inflation Targeting and Exchange Rate Volatility

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  • Victor Pontines

Abstract

This study empirically examines the issue on whether countries that target inflation systematically experience higher exchange rate volatility. A major challenge that immediately confronts such analysis is that countries do not choose their monetary regimes in a random fashion. In this paper, an attempt is made to take into account the problem of self-selection in the countries’ decision to target inflation via a treatment effect regression that estimates jointly the probability of being an inflation targeter and the outcome equation. The analysis indicates that nominal and real exchange rate volatility are both lower in inflation targeting countries than countries that do not target inflation. More importantly, the analysis also suggest that developing countries that target inflation have lower nominal and real exchange rate volatility than non-inflation targeting developing countries. In the case, of inflation targeting industrial countries, however, it is found to be higher.

Suggested Citation

  • Victor Pontines, 2011. "The Nexus Between Inflation Targeting and Exchange Rate Volatility," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp84, April.
  • Handle: RePEc:sea:spaper:sp84
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    File URL: http://www.seacen.org/GUI/pdf/publications/staff_paper/2011/staffpaper84.pdf
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    References listed on IDEAS

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    1. Devereux, Michael B. & Lane, Philip R., 2003. "Understanding bilateral exchange rate volatility," Journal of International Economics, Elsevier, vol. 60(1), pages 109-132, May.
    2. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 1-48.
    3. Bayoumi, Tamim & Eichengreen, Barry, 1998. "Exchange rate volatility and intervention: implications of the theory of optimum currency areas," Journal of International Economics, Elsevier, vol. 45(2), pages 191-209, August.
    4. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December.
    5. Rose, Andrew K., 2007. "A stable international monetary system emerges: Inflation targeting is Bretton Woods, reversed," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 663-681, September.
    6. Edwin M. Truman, 2003. "Inflation Targeting in the World Economy," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 346.
    7. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
    8. Heckman, James, 2013. "Sample selection bias as a specification error," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 31(3), pages 129-137.
    9. repec:hrv:faseco:34721963 is not listed on IDEAS
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    Cited by:

    1. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.

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