ABSTRACT
After the adoption of fl oating exchange rate regimes, several emerging markets decided to switch to an infl ation-targeting framework which entailed explicit medium-term quantitative targets for infl ation that their central banks had publicly declared.2 However, even after switching to infl ation targeting, an emerging market central bank (EMCB) has reasons to care about exchange rate movements and their effects on the fi nancial account balance. Firstly, due to the observed high degree of asset and liability dollarisation and shallow fi nancial markets, emerging markets are more susceptible to sudden capital account reversals, and an EMCB is more likely to actively respond to sudden movements in exchange rates when compared with, for example, the Federal Reserve or the Bank of England. Secondly, central banks in countries that depend heavily on exports for their economic welfare may be more inclined to bow to political pressure to adjust their exchange rates. An upcoming election, for instance, may compound that pressure.
