Interactions between Monetary Policy and Exchange Rate in Inflation Targeting Emerging Countries: The Case of Three East Asian Countries

Abstract

This paper investigates empirically how the reaction of monetary policy to exchange rate has changed after the adoption of inflation targeting regime in three East-Asian countries. Using a system equation of structural VAR and a single equation approaches, this paper shows that the reactions of monetary policy to exchange rate shocks as well as CPI (demand shocks) and output (supply shocks) have declined under the inflation targeting environment. The policy function reacts weakly to the exchange rate movements before and after the financial crisis of 1997 in two out of the three countries. These central banks react differently to inflation. Empirical estimations of policy reaction functions indicate that the policy maker in Philippines pays higher concerns on output gap stability in the post-crisis period although Philippines has implemented the inflation targeting regime. [PUBLICATION ABSTRACT]