Central banks are supposed to use the interest rate to achieve an inflation target and let the exchange rate float freely. So why do they often intervene in currency markets by buying and selling international reserves, and use a host of other measures to limit their currencies’ volatility?
LONDON – Say one thing and then do something else. That pretty much sums up current orthodoxy in emerging economies regarding exchange-rate management. Countries are supposed to use the interest rate to achieve an inflation target and let the exchange rate float freely. In practice, Asian and Latin American central banks often intervene in currency markets by buying and selling international reserves, and use a host of other measures to limit their currencies’ volatility.
That exchange-rate make-believe will be harder to keep up after a landmark speech last week by Agustín Carstens, General Manager of the Bank for International Settlements (BIS), at the School of Public Policy at the London School of Economics. In the past, the BIS has been regarded as a bastion of orthodoxy. But now the BIS is arguing that orthodoxy should be updated. Markets are bound to listen.
Inflation targeting can claim important achievements, which Carstens duly listed. It has helped bring inflation rates down in most emerging markets. It has also helped reduce what economists call exchange-rate pass-through – the immediate impact of exchange-rate depreciations on domestic inflation.
LONDON – Say one thing and then do something else. That pretty much sums up current orthodoxy in emerging economies regarding exchange-rate management. Countries are supposed to use the interest rate to achieve an inflation target and let the exchange rate float freely. In practice, Asian and Latin American central banks often intervene in currency markets by buying and selling international reserves, and use a host of other measures to limit their currencies’ volatility.
That exchange-rate make-believe will be harder to keep up after a landmark speech last week by Agustín Carstens, General Manager of the Bank for International Settlements (BIS), at the School of Public Policy at the London School of Economics. In the past, the BIS has been regarded as a bastion of orthodoxy. But now the BIS is arguing that orthodoxy should be updated. Markets are bound to listen.
Inflation targeting can claim important achievements, which Carstens duly listed. It has helped bring inflation rates down in most emerging markets. It has also helped reduce what economists call exchange-rate pass-through – the immediate impact of exchange-rate depreciations on domestic inflation.