Critically Evaluate Three Monetary Strategies of Central Banks: Exchange Rate Targeting, Monetary Targeting, and Inflation Targeting.
Alexis Gutiérrez
University of Essex
Department of Economics
Dr. F. Bohn
EC368 International Money and Finance
Term Paper 2001- 02
- Critically evaluate three monetary strategies of central banks: exchange rate targeting, monetary targeting, and inflation targeting.
On this essay I am going to evaluate the three basic frameworks of the strategies for monetary policy used by central banks. Here we are going to look at the advantages and disadvantages of each of these strategies.
Exchange Rate Targeting: First of all, lets define peg: “ is a system where countries stabilize their exchange rates around par values they retain the right to change. Under this system a country undertakes to intervene in the foreign exchange market to keep its currency within some margin, for example 1 per cent, of some given exchange rate parity, the ‘peg’ ”[1] There are two types of peg regimes for monetary policy: a currency board and full dollarization. In a currency board, the domestic currency is backed 100% by a foreign currency and the central bank or government, who fixes a conversion rate to this currency and stands ready to exchange domestically issued notes for the foreign currency on demand. Full dollarization involves eliminating altogether the domestic currency and replacing it with a foreign currency ( the U.S. dollar ). It represents a stronger commitment to monetary stability than a currency board because it makes it much more costly for the government to recover control over monetary policy and/or change the parity of the domestic currency. The main purpose of exchange rate targeting is to maintain the real exchange rate at some specific level. “ The target zone is a non-linear compromise between fixed exchange rates and freely flexible exchange rates. ”[2] In an exchange rate target zone, a country or group of countries sets explicit margins within exchange rates will be allowed to fluctuate. While the exchange rate is within
University of Essex
Department of Economics
Dr. F. Bohn
EC368 International Money and Finance
Term Paper 2001- 02
- Critically evaluate three monetary strategies of central banks: exchange rate targeting, monetary targeting, and inflation targeting.
On this essay I am going to evaluate the three basic frameworks of the strategies for monetary policy used by central banks. Here we are going to look at the advantages and disadvantages of each of these strategies.
Exchange Rate Targeting: First of all, lets define peg: “ is a system where countries stabilize their exchange rates around par values they retain the right to change. Under this system a country undertakes to intervene in the foreign exchange market to keep its currency within some margin, for example 1 per cent, of some given exchange rate parity, the ‘peg’ ”[1] There are two types of peg regimes for monetary policy: a currency board and full dollarization. In a currency board, the domestic currency is backed 100% by a foreign currency and the central bank or government, who fixes a conversion rate to this currency and stands ready to exchange domestically issued notes for the foreign currency on demand. Full dollarization involves eliminating altogether the domestic currency and replacing it with a foreign currency ( the U.S. dollar ). It represents a stronger commitment to monetary stability than a currency board because it makes it much more costly for the government to recover control over monetary policy and/or change the parity of the domestic currency. The main purpose of exchange rate targeting is to maintain the real exchange rate at some specific level. “ The target zone is a non-linear compromise between fixed exchange rates and freely flexible exchange rates. ”[2] In an exchange rate target zone, a country or group of countries sets explicit margins within exchange rates will be allowed to fluctuate. While the exchange rate is within
Bibliography: - Bernanke, B. and F. Mishkin, 1997, “ Inflation Targeting: Lessons from the International Experience ”, Princeton, Princeton University Press. - Griffiths, B. and Geoffrey E. Wood, 1981, “ Monetary Targets. ” Centre for Banking and International Finance at the City University. [3] Kurgman & Miller. “Exchange rate targets and currency bands.” Cambridge University, Printed in Great Britain (1992), pp. 26 [4] http://econ.worldbank.org/files/2458_wps2684.pdf [5] Griffiths, B. and Geoffrey E. Wood, 1981, “ Monetary Targets.” Centre for Banking and International Finance at the City University, pp. 51-52 [6] http://econ.worldbank.org/files/2458_wps2684.pdf [7] Bernanke, B. and F. Mishkin, 1997, “ Inflation Targeting: Lessons from the International Experience ”, Princeton, Princeton University Press.