Exchange Rates and Monetary Policy in Emerging Market Economies
Michael B. Devereux
University of British Columbia (UBC) - Department of Economics; Centre for Economic Policy Research (CEPR)
Philip R. Lane
Trinity College (Dublin) - Department of Economics; Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. 2874
This Paper investigates the effects of exchange rate regimes and alternative monetary policy rules for an emerging market economy that is subject to a volatile external environment in the form of shocks to world interest rates and the terms of trade. In particular, we highlight the impact of financial frictions and the degree of exchange rate pass through in determining the relative performance of alternative regimes in stabilizing the economy in the face of external shocks. Our results are quite sharp. When exchange rate pass-through is high, a policy of non-traded goods inflation targeting does best in stabilizing the economy, and is better in welfare terms. When exchange rate pass-through is low, however, a policy of strict CPI inflation targeting is better. In all cases, a fixed exchange rate is undesirable. In addition, financial frictions have no implications for the ranking of alternative policy rules.
Number of Pages in PDF File: 47
Keywords: Monetary policy, pass-through, financial frictions, emerging markets
JEL Classification: E50, F30
Date posted: August 1, 2001
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