Inflation targeting and exchange rate volatility smoothing: A two-target, two-instrument approach ¬リニ

a r t i c l e i n f o This paper introduces a strategy to model a small open economy, whose central bank has established two simultaneous policy objectives: an inflation target, and a maximum limit for nominal exchange rate volatility. In line with the Tinbergen–Aoki condition, the monetary authority establishes two policy instruments, one for accomplishing each target: the monetary policy rate, and the stock of foreign exchange reserves. Monetary policy analysis is built around a non-microfounded augmented New Keynesian DSGE model estimated through Bayesian techniques for the Guatemalan economy. It is found that each instrument is efficient in accomplishing its own target. Nevertheless, a coordinated effort is required for central bank policymakers before employing both instruments simultaneously, in order to avoid sending mixed signals to economic agents about its monetary policy stance, and endanger the achievement of its inflation target. During the past 30 years the way to conduct monetary policy has experienced a large transformation. A growing number of countries have adopted a monetary policy framework based on inflation targeting, since empirical evidence shows that it has effectively anchored inflation expectations and reduced long run inflation and output volatility (Batini et al. those central banks, whose monetary policy framework is based on exchange rate flexibility, do closely monitor their nominal exchange rate behavior to avoid its negative consequences on inflation, output, and financial stability (Calvo and Reinhart, 2000; De Gregorio, 2006). Hence, such a concern have lead them (some of them with higher intensity than others) to limit nominal exchange rate fluctuations through the establishment of different types of foreign exchange market intervention mechanisms, which in turn, might have an effect on monetary The Central Bank of Guatemala established inflation targeting in 2005, but fear of floating becomes evident through periodic-partially-sterilized interventions at the foreign exchange market (Castillo, 2010). Because of the importance to consider such intervention effects in the monetary transmission mechanism, this study introduces a strategy to model a central bank, whose monetary policy establishes two simultaneous targets: an inflation target, and a currency volatility target, where the latter refers to a maximum permissible fluctuation for the nominal exchange rate from its long run trend. In that order, we construct a New Keynesian DSGE non-microfounded model, whose monetary transmission is augmented to include a liquidity effect of interest rates on monetary aggregates, a direct impact of money supply and banking credit fluctuations on …