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The Exchange Rate Dimension of Inflation Targeting: Target Levels and Currency Volatility
Author(s) -
Du Plessis Stan,
Reid Monique Brigitte
Publication year - 2015
Publication title -
south african journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.502
H-Index - 31
eISSN - 1813-6982
pISSN - 0038-2280
DOI - 10.1111/saje.12080
Subject(s) - volatility (finance) , economics , monetary economics , currency , inflation targeting , exchange rate , volatility swap , monetary policy , inflation (cosmology) , econometrics , implied volatility , physics , theoretical physics
The surprising volatility of floating exchange rates have puzzled macroeconomists and challenged policy makers since the seventies. This is no less true in S outh A rica where the R and's volatility is a longstanding policy and business challenge. This paper extends the literature on nominal and institutional factors associated with currency volatility. R ose's description of inflation as “ B retton W oods in reverse” is the departure point and is read with B erganza and B roto's recent demonstration in a time series study that inflation targeting emerging market economies have experience higher exchange rate volatility. Meanwhile B leaney and T ian have shown the cross‐sectional connection between the level of inflation and exchange rate volatility. We build on B leaney and T ian's cross‐sectional approach to investigate the association between the level at which inflation targeting countries target inflation and exchange rate volatility over the long run. Crucially, we control for the average level of inflation and distinguish between inflation targeting countries that target high and low levels of inflation, in order to investigate whether the choice of the level of the inflation target (an institutional feature) is associated with greater exchange rate volatility.