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)| false Chung, Chae-Shick, and Se-Jik Kim, 2002, “ New Evidence on High Interest Rate Policy During the Korean Crisis,” in Korean Crisis and Recovery, ed.by ( David T. Coe, and Se-Jik Kimr Washington: International Monetary Fund; Seoul: Korea Institute for International Economic Policy).
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)| false Lane, Timothy, Atish Ghosh, Javier Hamann, Steven Philipps, Marianne Schulze Ghattas, and Tsidi Tsikata, 1999, “ ,” IMF Occasional Paper 178 ( IMF-Supported Programs in Indonesia, Korea, and Thailand, A Preliminary Assessment Washington: International Monetary Fund).
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Table 1 gives the starting dates for the crisis cases considered, as well as how many months it took for the nominal exchange rate to stop depreciating and volatility to reach levels typical of stable floating exchange rates. The dating of the beginning of the crisis is somewhat arbitrary, particularly for those countries in which the crisis involved a more gradual loss of nominal control (Bulgaria; Ecuador). Appendix I contains a summary of the key developments and economic indicators for each of the cases.
In cases where dollar-denominated liabilities are a high proportion of the total, even substantial depreciation of the currency and accompanying inflation—one possible way of resolving the interest rate trade off on domestic currency-denominated debt—will not work because it also raises the probability of default.
All the countries in our sample had open capital accounts and most maintained them through the crisis. Post-crisis capital controls have proven largely ineffective in situations when nominal stability had not already largely been restored (Thailand; Russia). They did not stop the exchange rate collapse and indeed may have promoted further capital outflow, at least in the short run. Malaysia introduced selective capital controls on a temporary basis in September 1998, after initial stabilization had been achieved. Meesook and others (2001) review Malaysia’s experience.
Reinhart and Rogoff (2002) characterize uncontrolled depreciations as “freely falling” exchange rate regimes to distinguish them from more functional floats.
Figure 2 demonstrates these conclusions by showing levels of the exchange rate, interest rates, and inflation for an average of Brazil, Korea, Malaysia, and Thailand. Mexico and Indonesia are excluded because the timing of their exchange rate trajectories is sufficiently different to obscure the implications of the average, but their outcomes are qualitatively similar. Appendix III shows real and nominal exchange rates, inflation, and interest rates for each of the countries in our sample.
The success of the 1990s crisis countries in reducing inflation contrasts favorably with the difficulty which countries hit by the debt crisis of the 1980s had in reducing inflation. However, the depth of the problem also differed. Whereas in the 1980s inflation was a chronic problem typically rooted in large fiscal imbalances, in most of the 1990s crisis countries, inflation (and monetization of fiscal deficits) was not a problem before the crises.
Russia also had an incomplete disinflation, reflecting its decision to maintain a highly depreciated level of the nominal exchange rate after initial stabilization. Turkey, a country that like Bulgaria and Ecuador had a recent history of high inflation, also benefited from a relatively small nominal appreciation despite having floated its currency. This suggests that history, as well as the type of exchange rate regime chosen, shapes the path of disinflation.
This is consistent with evidence in Goldfajn and Gupta (1999) on monetary policy after crises, and Borensztein and De Gregorio (1999), Goldfajn and Werlang (2000), and Choudhri and Hakura (2001) on inflation pass-through in developing countries. One important conclusion of this research is that exchange rate depreciation beyond levels that are consistent with some definition of long-run equilibrium (for example defined simply as the value associated with the long-run trend real exchange rate) is particularly inflationary. Lane and others (1999), and Ghosh and others (2002), contain fuller discussions of the evidence on the relationship between exchange rates and monetary policy in the post-crisis environment. More recent work by Christiano, Gust and Roldos (2002) and Caballero and Krishnamurthy (2002) tends to support the view, expressed in Ghosh et al (2002), that tight monetary policy is likely to be necessary after a crisis. There are also a variety of country studies such as Chung and Kim (2002) on Korea.
Where financial system vulnerabilities result mostly from excess domestic leverage rather than from liability dollarization, it may be more appropriate to keep interest rates lower and allow a larger depreciation (Malaysia).
Appendix II reports on the monetary policy framework post-crisis for each of the countries in our sample.
The goal is the ultimate objective of policy, such as stable prices and output close to its potential level. Intermediate targets are more immediately observable indicators of whether policy is adequate, such as the inflation forecast or monetary aggregates. Operating targets, such as interest rates or the exchange rate, are directly achievable by the central bank on a regular basis. Instruments, such as open market operations and foreign exchange market intervention, are means to achieve operating targets.
Increasing dollarization was an important factor making money demand hard to predict in Turkey, though the issue is more general.
Ghosh and others (2002) emphasize this point. Carstens and Werner (1999) are revealing on the futility of Mexico’s short-lived experience with money aggregate targeting in early 1995. See also Edwards and Savastano (1998).
Indonesia may represent something of an exception to the rule that monetary aggregates did not help guide policy. For a few key months in 1998, at least, base money did actually track targets quite closely. Two special factors may have been important here. First, Indonesian monetary policy credibility, and the level of the rupiah, had fallen to an extremely low point by April/May 1998, even relative to the other cases considered here, when the monetary aggregate ceilings started to bind effectively. In this context, even a crude policy of keeping aggregates constant was a major improvement. Second, the shocks that called for a contractionary monetary policy during this period tended to cause flight from bank deposits into rupiah cash, hence increases in money demand. Hence, a monetary aggregate target tended to at least give the correct sign to the policy response. In more typical cases, negative shocks may sometimes reduce cash demand, in which case a money aggregate target might well give the wrong sign for the policy response.
It its full-fledged form, inflation targeting involves: (1) the public announcement of medium-term numerical targets for inflation; (2) an institutional commitment to price stability as the primary goal of monetary policy, to which other goals are subordinated; (3) an information inclusive strategy in which many variables, and not just monetary aggregates or the exchange rate, are used for deciding the setting of policy instruments; (4) increased transparency of the monetary policy strategy through communication with the public and the markets; and (5) increased accountability of the central bank for attaining its inflation objectives. For discussions of inflation targeting in emerging markets, see Mishkin (2000), which contains this definition, as well as Masson and others (1997) and Carare and others (2002) and the many references cited therin. Stone (2003) discusses the move from informal to full-fledged inflation targeting.
Brazil also stands out as the only country in the sample that did not suffer a banking crisis along with the currency crisis. This was surely an important factor in permitting the authorities to create the new monetary policy framework, and indeed to stabilize, as quickly as they did.
Russia represents an intermediate case. It heavily managed its float in 1999, with months of exchange rate stability interrupted by adjustments of the level, achieved in part through substantial intervention. Towards the end of 1999 it moved to a de facto crawling peg. The heavy emphasis on the exchange rate target was facilitated by (i) its decision to maintain a highly depreciated level of the exchange rate; (ii) the fact that its prior default had rendered it somewhat less vulnerable to further attack; and (iii) strong fiscal performance, greatly abetted by the sharp rise in the price of oil in the post-crisis period.
A difference is that unlike sterilized intervention, the central bank incurs no foreign exchange risk.
As the Korean and Mexican examples illustrate, monetary policy is often tightened simultaneously with the intervention. We could, as a manner of terminology, call these interventions partially sterilized. It is useful to distinguish the monetary policy and intervention choices, however, for several reasons. First, in practice, the decision about what to do with monetary policy was a separate one from the decision to intervene (and sterilize). In the Mexico example, the dollars were simply lent directly; there was no automatic domestic monetary impact. More generally, monetary policy was typically conducted in terms of interest rate rules, so that foreign exchange interventions were automatically sterilized. Second, the local currency value of foreign exchange interventions often dwarfed the reductions in the money base associated with a monetary policy contraction. Thus, the measured share of the intervention that was sterilized was usually very large, even when the associated monetary contraction was important when measured in terms of interest rates.