Lucas Antonio Moisés Freddo
Master's – Inflation Targeting in Latin America: the role of the exchange rate
Advisor: Prof. Dr. Fernando Monteiro Rugitsky
Comission: Profs. Drs. Gilberto Tadeu Lima, Julia de Medeiros Braga and Nelson Henrique Barbosa Filho
Class: 217, FEA-5
Several Emerging Market Economies (EME) have adopted Inflation Targeting (IT) as their monetary policy framework in the past decades–generally after a period of some type of a fixed exchange rate policy. Under an IT regime, in theory, the exchange rate should freely float. In fact, monetary authorities should only care about the propagation of secondary effects of exchange rate changes on prices–through demand and/or expectations, but not trying to influence the exchange rate trajectory itself. The reality of EME, however, reveals that the exchange rate is of crucial importance not only for the conduction of monetary policy but also for its effects on the domestic economy, due to their susceptibility and vulnerability to pro-cyclical capital flows. In this vein, this dissertation aims at investigating how exchange rate movements influence interventions in the market of Latin American monetary authorities (Brazil, Chile, and Colombia) through two instruments, that is, through Foreign Exchange (FX) interventions and through short-term interest rate changes, estimating Monetary Reaction Functions (MRF) for the last variable. The main contribution is the incorporation of potential asymmetries–more concerned with currency appreciation or currency depreciation–in the behavior of monetary authorities. Findings shed light on the fact that, although the exchange rate has played a pivotal role for their IT regimes, the utilization of instruments has varied in terms of intensity, purpose, and asymmetry when it comes to exchange rate movements. In Brazil, monetary authorities have asymmetrically behaved towards currency depreciation, with both instruments. In Chile, the asymmetry has been towards currency appreciation, also with both instruments, but FX interventions have been much more modest. In Colombia, monetary authorities have asymmetrically behaved towards currency appreciation in the FX market; no evidence of asymmetry has been found through interest rate changes. The potential reason behind asymmetries is also different: whereas in Brazil monetary authorities have been more concerned about currency depreciation, potentially due to issues regarding their inflation goals, in Chile and Colombia, they have been more concerned about currency appreciation, potentially due to issues regarding their balance of payments. Besides, the intensity and frequency of interventions, especially in the FX market, arise the question, for the cases of Brazil and Colombia, whether monetary authorities have tried to influence somehow the exchange rate trajectory itself.
*Abstract provided by the author