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Hybrid Inflation Targeting Regimes1

This paper uses a DSGE model to examine whether including the exchange rate explicitly in the central bank’s policy reaction function can improve macroeconomic performance. It is found that including an element of exchange rate smoothing in the policy reaction function is helpful both for financially robust advanced economies and for financially vulnerable emerging economies in handling risk premium shocks. As long as the weight placed on exchange rate smoothing is relatively small, the effects on inflation and output volatility in the event of demand and cost-push shocks are minimal. Financially vulnerable emerging economies are especially likely to benefit from some exchange rate smoothing because of the perverse impact of exchange rate movements on activity.

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Paper provided by Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines in its series ILADES-Georgetown University Working Papers with number inv226.

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Length: 54 pages
Date of creation: Dec 2009
Date of revision:
Handle: RePEc:ila:ilades:inv226
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  1. Federico Ravenna & Fabio M. Natalucci, 2008. "Monetary Policy Choices in Emerging Market Economies: The Case of High Productivity Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(2-3), pages 243-271, 03.
  2. Drew, Aaron & Hunt, Benjamin, 2000. "Efficient simple policy rules and the implications of potential output uncertainty," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 143-160.
  3. Ehrmann, M. & Smets, F., 2001. "Uncertain Potential Output: Implications for Monetary Policy," Papers 59, Quebec a Montreal - Recherche en gestion.
  4. Tille, Cedric, 2001. "The role of consumption substitutability in the international transmission of monetary shocks," Journal of International Economics, Elsevier, vol. 53(2), pages 421-444, April.
  5. Wei Dong, 2013. "Do central banks respond to exchange rate movements? Some new evidence from structural estimation," Canadian Journal of Economics, Canadian Economics Association, vol. 46(2), pages 555-586, May.
  6. Batini, Nicoletta & Harrison, Richard & Millard, Stephen P., 2003. "Monetary policy rules for an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 2059-2094.
  7. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 295-330, 03.
  8. Joshua Aizenman & Michael Hutchison & Ilan Noy, 2008. "Inflation Targeting and Real Exchange Rates in Emerging Markets," NBER Working Papers 14561, National Bureau of Economic Research, Inc.
  9. Edwin M. Truman, 2003. "Inflation Targeting in the World Economy," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 346, May.
  10. Eric Parrado, 2004. "Singapore's Unique Monetary Policy: How Does it Work?," IMF Working Papers 04/10, International Monetary Fund.
  11. Nicoletta Batini & Paul Levine & Joseph Pearlman, 2007. "Monetary Rules in Emerging Economies with Financial Market Imperfections," NBER Chapters, in: International Dimensions of Monetary Policy, pages 251-311 National Bureau of Economic Research, Inc.
  12. Luis F. Céspedes & Claudio Soto, 2005. "Credibility and Inflation Targeting in an Emerging Market: Lessons from the Chilean Experience," International Finance, Wiley Blackwell, vol. 8(3), pages 545-575, December.
  13. Kai Leitemo & Ulf Soderstrom, 2001. "Simple monetary policy rules and exchange rate uncertainty," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  14. Erceg, Christopher J. & Levin, Andrew T., 2003. "Imperfect credibility and inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 915-944, May.
  15. Eduardo Morón & Diego Winkelried, 2003. "Monetary Policy Rules for Financially Vulnerable Economies," IMF Working Papers 03/39, International Monetary Fund.
  16. Tony Cavoli & Ramkishen S. Rajan, 2006. "Monetary Policy Rules For Small And Open Developing Economies: A Counterfactual Policy Analysis," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 31(1), pages 89-111, June.
  17. Sebastian Edwards, 2006. "The Relationship Between Exchange Rates and Inflation Targeting Revisited," NBER Working Papers 12163, National Bureau of Economic Research, Inc.
  18. Leonardo Leiderman & Rodolfo Maino & Eric Parrado, 2006. "Inflation Targeting in Dollarized Economies," IMF Working Papers 06/157, International Monetary Fund.
  19. Camilo E Tovar, 2006. "Devaluations, output and the balance sheet effect: a structural econometric analysis," BIS Working Papers 215, Bank for International Settlements.
  20. Eric Parrado, 2004. "Inflation Targeting and Exchange Rate Rules in an Open Economy," IMF Working Papers 04/21, International Monetary Fund.
  21. Del Negro, Marco & Schorfheide, Frank & Smets, Frank & Wouters, Rafael, 2007. "On the Fit of New Keynesian Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 123-143, April.
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