Exchange rate depriciation and reserve accumulation
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An increasingly dominant view on monetary policy suggests that central banks should
adopt inflation targeting (IT) regimes, as advocated by Svensson (1999, 2000), Woodford
(2003), and others. Following this advice, several Latin American central banks now claim to
have established IT regimes. This process has coincided with a period of low and declining
inflation in most countries, which has been cited as prima facie evidence of the superiority of
IT over other monetary rules.
However, actual IT regimes in Latin America appear to be rather different from their theo-
retical counterparts, most markedly on the extent to which central banks have engaged on fo-
reign exchange intervention and, more recently, accumulated foreign exchange reserves. Con-
ventional theory prescribes that an ideal IT regime should have an inflation target as its primary
objective1
and, therefore, should not simultaneously pursue an exchange rate goal. It follows
that the exchange rate should be allowed to float. In contrast, Latin American central banks
have intervened actively to stabilize foreign exchange rates. In addition, they have recently in-
creased their stocks of foreign exchange rate reserves drastically. This represents a challenge
for dominant IT theories, which are typically silent about the role of foreign reserves.
The objective of this paper is to document this state of affairs, identify possible inter-
pretations, and derive implications for IT and monetary management. To this end, the paper
includes a review of the inflation targeting experiences in Brazil, Colombia, Chile, and Peru,
with emphasis on the actual details of, and rationale for, reserve accumulation and foreign
exchange intervention. Having presented the stylized facts, the paper then discusses some
I hope it you
____________
here is your answer :-
An increasingly dominant view on monetary policy suggests that central banks should
adopt inflation targeting (IT) regimes, as advocated by Svensson (1999, 2000), Woodford
(2003), and others. Following this advice, several Latin American central banks now claim to
have established IT regimes. This process has coincided with a period of low and declining
inflation in most countries, which has been cited as prima facie evidence of the superiority of
IT over other monetary rules.
However, actual IT regimes in Latin America appear to be rather different from their theo-
retical counterparts, most markedly on the extent to which central banks have engaged on fo-
reign exchange intervention and, more recently, accumulated foreign exchange reserves. Con-
ventional theory prescribes that an ideal IT regime should have an inflation target as its primary
objective1
and, therefore, should not simultaneously pursue an exchange rate goal. It follows
that the exchange rate should be allowed to float. In contrast, Latin American central banks
have intervened actively to stabilize foreign exchange rates. In addition, they have recently in-
creased their stocks of foreign exchange rate reserves drastically. This represents a challenge
for dominant IT theories, which are typically silent about the role of foreign reserves.
The objective of this paper is to document this state of affairs, identify possible inter-
pretations, and derive implications for IT and monetary management. To this end, the paper
includes a review of the inflation targeting experiences in Brazil, Colombia, Chile, and Peru,
with emphasis on the actual details of, and rationale for, reserve accumulation and foreign
exchange intervention. Having presented the stylized facts, the paper then discusses some
I hope it you
____________
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