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The Nexus Between Inflation Targeting and Exchange Rate Volatility

  • Victor Pontines

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.

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This book is provided by South East Asian Central Banks (SEACEN) Research and Training Centre in its series Staff Papers with number sp84 and published in 2011.
ISBN: -
Handle: RePEc:sea:spaper:sp84
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  1. Devereux, M.B. & Lane, P.R., 2002. "Understanding Bilateral Exchange Rate Volatility," CEG Working Papers 20025, Trinity College Dublin, Department of Economics.
  2. 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.
  3. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  4. Heckman, James, 2013. "Sample selection bias as a specification error," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 31(3), pages 129-137.
  5. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  6. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," Research Department Publications 4205, Inter-American Development Bank, Research Department.
  7. Edwin M. Truman, 2003. "Inflation Targeting in the World Economy," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 346.
  8. 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.
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