THE HYBRID APPROACH OF INFLATION TARGETING: WHAT OPPORTUNITIES FOR AN EMERGING ECONOMY LIKE TUNISIA?

Abstract

After economic crises happening in many emerging countries, flexible exchange rates became a required theoretical condition helping to target inflation. Many countries stopped using exchange rate as an anchor for monetary policy and started using inflation targeting framework. In emerging countries, monetary authorities work to stabilize the exchange rate because of their “fear of floating”. They are against high volatility of interest rate allowing speculative attacks and causing free fluctuations of their national currency. To avoid uncontrolled market movements, they have to choose between active and public exchange rate management and tight inflation targeting. In the same vein, Central bank of Tunisia follows financial measures linked closely to inflation without focusing especially on monetary aggregates in order to study a possible transition to targeting inflation strategy. It uses a simple Taylor rule where interest rates adjustment are guided by the anticipated inflation deviation from its original target and also by the gap between observed and potential GDP.As an emerging economy with a high degree of financial vulnerability, and facing different shocks, Tunisia should adopt a hybrid rule of inflation targeting in an open economy. This hybrid rule explicitly takes into account the evolution of the exchange rate in the reaction function of the central bank.