Working Paper: CEPR ID: DP2874
Authors: Michael B. Devereux; Philip R. Lane
Abstract: 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
Keywords: emerging markets; financial frictions; monetary policy; pass through
JEL Codes: E50; F30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high exchange rate pass-through (F31) | better outcomes under non-traded goods inflation targeting (E61) |
| low exchange rate pass-through (F31) | better performance of strict CPI inflation targeting (E31) |
| financial frictions (G19) | ranking of alternative monetary rules in terms of welfare (E19) |
| financial frictions (G19) | relative performance of the policies (P17) |