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Exchange Rates, Inflation and Monetary Policy Objectives in Open Economies: The Experience of Chile

  • Rodrigo Caputo

This paper characterizes, empirically, the conduct of monetary policy in a small open economy. In particular, using as a case study the Chilean inflation targeting experience, we assess the role of the exchange rate in the determination of the interest rate. We conclude that Chile has adopted what Svensson (1997) calls a gradual approach to targeting inflation. This means, in practice, that the central bank modifies its policy instrument, the interest rate, whenever expected inflation or output deviate from its target. In this context, we find evidence that the monetary authorities also react to real exchange rate misalignments. This reaction is comparatively larger than that found in developed economies. Finally, the evidence, although not conclusive, seems to suggest a non linear response to exchange rate misalignments: the central bank reacts strongly to large deviations rather than to small ones

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Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 298.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:298
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