Monetary Policy Frameworks for Emerging Markets

Monetary Policy Frameworks for Emerging Markets

Edited by Gill Hammond, Ravi Kanbur and Eswar Prasad

Financial globalization has made monetary policy formulation in emerging market economies increasingly complicated. This timely set of studies looks at the turmoil in global financial markets, which coupled with volatile inflation poses serious challenges for central banks in these countries. Featuring papers from the research frontier and front-line policymakers in developing and emerging market economies, the book addresses questions such as ‘What monetary policy framework is most suitable for these countries to confront the new challenges while they continue to open up to trade and financial flows?’, ‘What are the linkages between monetary stability and financial stability?’ and ‘Is inflation targeting or a fixed exchange rate regime preferable for developing and emerging markets?’

Chapter 10: Inflation Targeting and Exchange Rate: Notes on Brazil’s Experience

Paulo Vieira da Cunha, Daniela Silva Pires and Wenersamy Ramos de Alcântara

Subjects: development studies, development economics, economics and finance, development economics, money and banking


Paulo Vieira da Cunha, Daniela Silva Pires and Wenersamy Ramos de Alcântara 10.1 INTRODUCTION In 2004, the Central Bank of Brazil (Banco Central do Brasil, henceforth BCB) introduced a program of sterilized interventions in the foreign exchange market, in effect to July 2008. Reserves increased by US$864 million in 2005, US$32.04 billion in 2006, US$94.5 billion in 2007, and US$15.19 billion by July 2008.1 The primary aim of the program is to accumulate precautionary reserves to buttress the credibility and increase the resilience of the macroeconomic regime. The secondary aim is to reduce exchange rate volatility by acting in anticipation of what the BCB knows to be relatively large and atypical market performance. The policy of sterilized interventions does not aim to influence the level of the exchange rate. Nevertheless, the build-up of reserves – and the overall steady decrease in net external liabilities of the public sector – reduces the perception of country risk. Thus, indirectly, given the market’s positive reaction to strengthened fundamentals, an outcome of the policy has been an increase in foreign investment, notably foreign direct investment (FDI), and greater capital inflows. The BCB’s stated goals and practice in its interventions differ markedly from those of other recent intervention experiences, for example China and even Colombia, where there has been an explicit aim to influence the level of the exchange rate. The contrast with Colombia, as examined by Kamil (2008), is illustrative. Undoubtedly, in Brazil as well, the level and trend of the...

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