Inflation-targeting central bank responses to exchange rate shocks: evidence from Latin America

José J. Cao-Alvira, Jose Gomez-Gonzalez and Julian Vallejo-Peña

Applied Economics Letters, 2025, vol. 32, issue 17, 2549-2553

Abstract: This paper examines the impact of real exchange rate shocks on policy interest rates in the five major inflation-targeting economies in LATAM. Using a SVAR model with identification based on sign and short-run restrictions, we find that monetary policy reacts to real exchange rate shocks across all five countries. Specifically, interest rates rise directly in response to a positive real exchange rate shock (appreciation). A subsequent reversal occurs after a few quarters, with statistical significance observed in three countries. Additionally, shocks to the policy rate are demonstrated to effectively induce a real depreciation of the exchange rate.

Date: 2025
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DOI: 10.1080/13504851.2024.2335372

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