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Examining the asymmetric monetary policy response to foreign exchange market conditions in emerging and developing economies

Helena Glebocki Keefe () and Hedieh Shadmani ()
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Helena Glebocki Keefe: Fairfield University
Hedieh Shadmani: Fairfield University

International Economics and Economic Policy, 2020, vol. 17, issue 2, No 7, 503-530

Abstract: Abstract In many emerging market economies that have adopted inflation targeting, policymakers are concerned with the effects that strong appreciation/depreciation pressures and excessive volatility in exchange rates may have on economic stability and their ability to reach their inflation targets. The research in this paper addresses whether central banks have an asymmetric response to exchange rate conditions with respect to meeting their monetary policy objectives. Using a panel of 30 emerging market and developing economies, we employ a panel threshold regression analysis to determine whether policymakers respond differently during appreciation versus depreciation periods, during periods of high versus low exchange rate volatility, or when the country has a relatively high exchange rate pass-through effect. We find that policymakers react more strongly and significantly to depreciations with increases in domestic interest rates, while remaining inactive during periods of appreciation. Yet, during appreciationary periods, they react more strongly to deviations in output from its potential, suggesting a concern over competitiveness. Furthermore, volatility in exchange rates is a significant concern to policymakers, as they regularly claim, and when volatility is sufficiently high, policymakers react with higher interest rates to maintain stability and mitigate capital outflows. Lastly, with a stronger exchange rate pass-through effect, policymakers are more responsive to depreciationary pressure as it affects their ability to reach inflation targets.

Keywords: Exchange rates; Optimal monetary policy; Asymmetric preferences; Inflation targeting; Emerging markets; Exchange rate pass-through effect; Exchange rate volatility (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s10368-020-00460-8

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