Inflation targeting and debt crises in the open economy: A note
The first time I met Alexander Swoboda was about ten years ago when he was visiting the Research Department of the IMF. Alexander and I collaborated, together with Jeromin Zettelmeyer and Michael Mussa, on an all-encompassing paper on reforming the international financial architecture (Mussa et al. 2000). This paper had a big impact – on me at least, since I am still working on the questions that we discussed at that time. This chapter is therefore naturally related to international financial architecture, namely a certain new “conventional wisdom” about the appropriate exchange rate regimes for developing countries. At the risk of oversimplifying, I would define its core elements as follows: (1) inflation targeting is the best nominal anchor for an autonomous monetary policy; (2) however, some countries may prefer to adopt the currency of another country rather than develop an inflation-targeting regime of their own. This view is consistent with the “polar” or “corner” view of exchange rate regimes, to which Alexander Swoboda was an early contributor (Swoboda 1986; Eichengreen 1994; Fischer 2008). But the new conventional wisdom goes further than simply emphasizing the inherent fragility of a fixed but adjustable exchange rate peg in a world of capital mobility: it also outlines a long-run future for the international monetary system, as a set of inflation-targeting currency areas linked to each other by floating exchange rates. It is not even clear that the world needs coordination mechanisms or institutions to manage such a “system” to the extent that the gains from international monetary coordination are small or difficult to achieve (Rose 2007). I am going to cast a somewhat critical look on this “new conventional wisdom,” but before I do so, let me clarify beforehand that this chapter is not meant as a defense of old-style fixed currency pegs. Fixed but adjustable currency pegs have demonstrated their instability and macro-financial costs on many occasions. By contrast, floating exchange rate cum inflation-targeting regimes have so far largely fulfilled the expectations of their proponents. They are more stable than fixed pegs, and they have produced better macro-economic outcomes in the emerging market countries that have adopted them (Rose 2007).