IPS Working Papers No. 16

IPS WORKING PAPERS No. 16

Exchange Rate Arrangements For East Asia Post-Crisis: Examining The Case For Open Economy Inflation Targeting

Tony Cavoli and Ramkishen Rajan

Abstract

The infeasibility of a monetary union for East Asia in the near future, as well as the limitations of other forms of super fixes, appears to leave a flexible regime as the only viable policy option. This paper first deliberates on the case for and against a flexible regime. To anticipate the main conclusion -- while favoring relatively more flexible regimes, emerging economies in East Asia and elsewhere have continued to heavily manage their currencies despite being officially described as “floaters”. The paper goes on to explore the case for and operational mechanics behind an open inflation targeting regime which has increasingly been advocated for small and open economies in East Asia and elsewhere. The importance of incorporating the exchange rate in open economy monetary policy rules is stressed.

Contents

SECTIONS

1. Introduction 1

2. The Flexible Exchange Rate Option Reconsidered 7

2.1 Reasons to Favor Flexibility 7

2.2 Reasons for a "Fear of Floating" 10

3. The Impossible Trilogy Revisited 13

4. Open Economy Inflation Targeting: Role of the Exchange Rate 16

4.1 Monetary Policy Rules in Open Economies 16

4.2 Exploring the Loss Function of the Monetary Authority in an Open Economy 21

5. Concluding Remarks 24

References 27

Order

Tony Cavoli and Ramkishen Rajan (2003), Exchange Rate Arrangements For East Asia Post-Crisis: Examining The Case For Open Economy Inflation Targeting, Singapore: IPS, 31 pages.

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