Should central banks target domestic inflation or nominal exchange rates?*

Central banks of the industrialized countries – such as those of the United States and the United Kingdom – have frequently been required by some policy-makers to ‘loosen’ their money stance, and to stimulate a faltering economy by spurring exports. This objective of targeting domestic nominal exchange rates often coincides with an economy hovering near full employment, and thus runs counter to the central bank’s objective of ‘cooling down’ an overheating economy with a tighter monetary policy.