How Should Emerging Economies Float Their Currencies?

28 Pages Posted: 20 Dec 2002

See all articles by Felipe Larrain

Felipe Larrain

Pontificia Universidad Catolica de Chile

Andrés Velasco

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Abstract

Floating exchange rates seem to be gaining ground in Latin America, East Asia and the transition economies. The recent crises left many economies with no alternative but to float. Others have moved toward floating, searching for greater flexibility and insulation from external shocks. The question for most emerging market economies, then, is no longer 'to float or not to float', but 'how' to float. Four issues arise in this regard. The first is how to float and have low inflation. The second is whether floating provides as much insulation as conventional theory predicts, especially in the presence of dollarized liabilities. Which leads to the third point: the relationship between the stability of the exchange rate and that of the financial system. The fourth is how to conduct monetary policy under a float, and the role of inflation targeting. We consider each of these points in turn, and conclude that a workable model of how to float seems to be emerging from the so-far successful experience of countries like Chile and Brazil. It involves the adoption of an inflation target as the main anchor for monetary policy, coupled with a monetary policy reaction function that - aside from reacting to the output gap and other determinants of the inflation rate - reacts also partially to movements in the nominal exchange rate.

JEL Classification: F3, F4, E4, E5

Suggested Citation

Larrain, Felipe and Velasco, Andrés, How Should Emerging Economies Float Their Currencies?. Available at SSRN: https://ssrn.com/abstract=317344

Felipe Larrain (Contact Author)

Pontificia Universidad Catolica de Chile ( email )

Av. Vicuna Mackenna 4860
Macul. Correo 17
Santiago
Chile
56 2 354-4027 (Phone)
56 2 553-2377 (Fax)

Andrés Velasco

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
43
Abstract Views
1,075
PlumX Metrics