Inflation Targeting in Dollarized Economies

Abstract

The shift to inflation targeting has contributed to the relatively low inflation observed in some emerging market economies although, as noted by many economists, the preconditions required for a successful implementation were not in place. The existence of managed exchange rate regimes, a narrow base of domestic nominal financial assets, the lack of market instruments to hedge exchange rate risks, together with fear of floating and dollarization, have been stressed as factors that might weaken the efficacy of monetary policy. By examining various aspects of monetary transmission and policy formulation in two highly dollarized economies (Peru an Bolivia) vis-à-vis two economies with low levels of dollarization (Chile and Colombia), we found that while dollarization imposes differences in both the transmission capacity of monetary policy and its impact on real and financial sectors, it does not preclude the use of inflation targeting as a policy regime. JEL Classification Numbers: E31, E4, E5

Effectiveness of monetary policy: evidence from Turkey

“…Literature is split up about dollarization: one group defends a positive relationship (Leiderman et al, 2006), and the other claims a negative relationship (Saborowski and Weber, 2013). Our findings are consistent with those of Leiderman et al (2006).…”

“…Dollarization and flexibility in exchange rate regime are also important as interest rate pass-through can be weaker in highly dollarized economies and low exchange rate flexibility Saborowski and Weber, 2013). Dollarization also makes banks vulnerable to exchange rate risks and can have a positive impact on interest rate pass-through (Leiderman et al, 2006). We measure exchange rate flexibility as the ratio of foreign currency loans to M2 monetary aggregate (FCLM2).…”

“…Effectiveness of transmission channels require a competitive banking sector, welldeveloped stock and credit markets, a fully liquid financial sector, totally independent central bank, maximum quality of institutional and regulatory environment, a floating exchange rate regime, full market development and effective secondary market for government securities (Cotarelli and Kourelis, 1994;Cottarelli et al, 1995;Cecchetti, 1999;Ehrmann et al, 2001;De Bondt (2002); Sorensen and Werner, 2006;Leiderman et al, 2006;Ito and Sato, 2006;Betancourt et al (2008); Frisancho-Marischal and Howells (2009) ;Saborowski and Weber, 2013;Leroy and Lucotte, 2015). Following this long recipe of the earlier literature, we use proxies representing these factors as interaction variables.…”

How much should inflation targeters care about the exchange rate?

“…23 See e.g., Brook (2002), Ragan (2005), and Taylor (2001). 24 See e.g., Mohanty and Klau (2004), Frommel and Schobert (2006), Leiderman et al (2006), Dong (2008), and Aizenman and Hutchison (2008). 25 See e.g., Ball (2000), Batini et al (2001), and Taylor (2001).…”

Monetary policy and macroeconomic stability in Latin America: The cases of Brazil, Chile, Colombia and Mexico

“…This is because inflation targeting was formally adopted in 2002, which would have severely reduced degrees of freedom in the post-regime change sample. The Peruvian economy is also highly dollarised, which makes the monetary transmission mechanism somewhat different from those in the countries under examination (Leiderman et al, 2006). became stronger and more persistent in Brazil and Chile in the current regime.…”