Inflation targeting in advanced vs. emerging economies before and after the crisis

Abstract

Emerging economies have specificities which distance them compared to advanced economies in practicing inflation targeting (IT) monetary regime. One of the main differences in performing IT in advanced compared to emerging economies is “fear of floating” problem in emerging group. However, on the road from exchange rate (ER) as a nominal anchor to IT, differences between advanced and emerging economies concerning “fear of floating” have been more or less narrowed. In this paper we are concentrated to selected aspects of ER pass-through to prices and output, as well as (in)direct monetary policy reactions to ER shocks, trying to find out is significant difference observable between advanced and emerging IT countries in pre-crisis period and (post)crisis period. The comparison is made on the basis of forecast error variance decompositions from estimated Vector Autoregression (VAR) / Vector Error Correction (VEC) models. “Fear of floating” phenomenon should not be exclusively applied to emerging economies, especially in the crisis period burdened with external shocks. The role of ER in IT monetary framework is strengthened with higher internal vulnerability to ER shocks, despite the level of economic development. Advanced countries more use interest rate as an indirect way to withstand ER shocks, while emerging economies more use direct way via foreign exchange interventions to withstand the ER shocks.

Keywords

• inflation targeting
• exchange rate shocks
• internal vulnerability
• monetary response
• “Fear of floating”
• advanced economies
• emerging economies