Review of Finance Advance Access published online on April 30, 2009
Review of Finance, doi:10.1093/rof/rfp004
Inflation Targeting and Exchange Rate Regimes: Evidence from the Financial Markets*
1 Stern School of Business, New York University
2 IMF
Inflation targeting is gaining popularity as a framework for conducting monetary policy. At the same time many countries employ some sort of foreign exchange intervention policy assuming that these two policies can coexist. This paper attempts to show that both policies are not sustainable. Israel is a classic test case. We test our hypothesis using information from the financial markets. The results support the hypothesis that both policies cannot be sustained in the long run. The conclusion is that a credible monetary policy aimed at inflation targets should be conducted in a free floating exchange rate regime.
JEL Classification: E52, E58, F31, G13
* The views expressed in this paper are the authors’ only. We would like to thank Nissan Liviatan, Paul Wachtel, José Campa, Yoav Friedman, Sigal Ribbon, Oved Yosha for their helpful comments and suggestions. Special thanks to an anonymous referee and to the editor, Franklin Allen, for their excellent comments and suggestions that greatly improved the paper. We would also like to thank Rik Sen for his valuable assistance and remarks, to Roy Stein and Limor Baruch for their assistance in the early stages of research, to Lorenzo Naranjo for his editorial assistance and to Rachel Towse for patient typing.