Editors’ Summary

Abstract

Editors’ Summary Claudio Raddatz and Roberto Chang With the advent of the millennium several central banks in Latin America adopted inflation targeting (IT) as a framework for monetary policy analysis and implementation. In so doing, they joined the Reserve Bank of New Zealand and other central banks in advanced economies where IT had been credited with successfully reducing inflation at relatively little cost in terms of employment and growth. As recently discussed by Powell (2012) and Céspedes, Chang, and Velasco (forthcoming),1 however, the behavior of Latin American inflation targeters has sometimes differed notably from that of their advanced country counterparts. Perhaps this is clearest when one considers the role of the exchange rate: while flexible exchange rates are an integral part of conventional IT, Latin central banks have often intervened in foreign exchange markets. In fact, foreign exchange intervention has at times worked at odds with the inflation objective (Chang, 2007). Beyond exchange rate interventions, IT central banks in Latin America have resorted to policy tools other than a conventional reference interest rate. The use of such unconventional tools—which include reserve requirements, liquidity facilities, and central bank debt management—has actually become more frequent following the 2007–08 global financial crisis (see Montoro and Moreno, 2011, for example) in a way that seems complementary to standard policy tools (Powell, 2012). This trend reflects an ongoing reconsideration of the role of unconventional policies in IT, partly brought about by the need to find additional sources of monetary stimulus in advanced countries after policy rates were brought to their minimum level of zero. But, as emphasized in Powell (2012) and Céspedes, Chang, and Velasco (forthcoming), unconventional policies in Latin IT countries were often seen even before the global crisis. [End Page vii] This state of affairs has prompted an active debate on inflation targeting, its prospects, and its alternatives in the emerging world. This volume of Economía contributes to the debate by presenting five studies on the recent experience and performance of central bank policies in Latin American inflation-targeting countries, with emphasis on whether and how unconventional tools and objectives can be reconciled with received wisdom about IT. The studies, which were part of a project on these topics sponsored by the Red de Centros of the Inter-American Development Bank, attempt to provide a narrative of the experience of different IT countries. In addition, they implement various formal techniques in order to model aspects of unconventional policies and quantify their impact in Latin America. The paper by Franz Hamann, Marc Hofstetter, and Miguel Urrutia discusses Colombia’s recent experience, a main aspect of which is that the Banco de la República intervened often, and sometimes quite actively, in the foreign exchange market. According to the authors, these interventions were aimed at preventing excessive exchange rate appreciation, driven by strong inflows of foreign capital. Accordingly, they develop an extension of the basic New Keynesian model in order to allow for a role of the real exchange rate and foreign exchange intervention. The extension assumes that aggregate demand for domestic goods depends on the real exchange rate. In turn, the real exchange rate is determined by the interaction of the current account, the financial account of balance of payments, and a policy rule for foreign exchange intervention. The model is estimated to Colombian data via Bayesian techniques. Among other interesting findings, Hamann, Hofstetter, and Urrutia’s estimations indicate that their proposed foreign-exchange-intervention rule for the Banco de la República exhibits a significant response to perceived misalignments of the real exchange rate. On the other hand, they also find that the estimated coefficients of their model imply a very weak interaction between foreign sector variables, including the real exchange rate, and the model’s domestic block, which determines inflation, output, and interest rates. The conclusion is, then, that foreign exchange intervention in Colombia, while quite visible, has had negligible impact on the dynamics of main real aggregates. This raises the question of why the Banco de la República has bothered to intervene in the foreign exchange market at all. While the paper does not directly address this question, Hamann, Hofstetter, and Urrutia conjecture...