Can emerging markets float? Should they inflation target? 1

The hot debate over the best monetary-cum-exchange-rate regime for developing countries shows no signs of cooling down. The Asian crisis and its fallout in Latin America and Eastern Europe have convinced many observers that soft currency pegs are crisis prone and that emerging markets should embrace greater exchange rate flexibility. The Turkish crisis reinforced that view. But worries that greater flexibility will impede market access, hinder financial development, and undermine rather than underpin financial stability have led others to advocate moving in the opposite direction — that is, hardening the peg by installing a currency board or dollarizing. ² While there are prominent examples of countries that have moved both ways — Ecuador and El Salvador have dollarized while Brazil has embraced greater flexibility — many developing countries continue to occupy the middle ground in the sense of making extensive use of their reserves so as to limit the variability of their exchange rates. ³