Inflation Targeting in Dollarized Economies

Abstract

An increasing number of emerging market economies have been adopting IT as their monetary policy regime. There is reason to believe that this shift has contributed to the relatively low inflation observed in these economies.² This outcome has surprised those who maintained that these economies are far away from the preconditions required for implementing IT. In particular, the existence of managed exchange rate regimes under foreign exchange market intervention, of a narrow base of domestic nominal financial assets and the lack of market instruments to hedge exchange rate risks, together with fear of floating, have been stressed as factors that drastically weaken the efficacy of monetary policy. Accordingly, these factors have been frequently seen as obstacles to IT implementation in a typical emerging market economy.

We thank Alain Ize, Eduardo Levy Yeyati, Klaus Schmidt-Hebbel and participants at the April 2005 Lima conference for their valuable comments. We also appreciate the editing comments provided by Graham Colin-Jones. The usual disclaimer applies.