Seven possible nominal variables are considered as candidates to be the anchor or target for monetary policy. The context is countries in Latin America and the Caribbean (LAC), which tend to be price takers on world markets, to produce commodity exports subject to volatile terms of trade, and to experience procyclical international finance. Three candidates are exchange rate pegs: to the dollar, euro and SDR. One candidate is orthodox Inflation Targeting. Three candidates represent proposals for a new sort of inflation targeting that differs from the usual focus on the CPI, in that prices of export commodities are given substantial weight and prices of imports are not: PEP (Peg the Export Price), PEPI (Peg an Export Price Index), and PPT (Product Price Targeting). The selling point of these production-based price indices is that each could serve as a nominal anchor while yet accommodating terms of trade shocks, in comparison to a CPI target. All seven nominal anchors deliver greater overall nominal price stability in our simulations than the inflationary historical monetary regimes actually followed by LAC countries (with the exception of Panama). A dollar peg does not particularly stabilize domestic commodity prices. As hypothesized, a product price target generally does a better job of

“While the new policy direction has successfully uprooted the previous regime, it has failed to establish a flourishing alternative. More worrying still, in terms of future prospects, has been the loss of policy autonomy, at both the microeconomic and macroeconomic levels, and the narrowing of the room for policy manoeuvre. ” Rubens Ricupero, Secretary General of UNCTAD (UNCTAD 2003) Recent economic policy experience in developing countries has led many to conclude either that there is no “policy space ” for economic policy alternatives and/or that mainstream economic policy practice is highly deflationary. The lack of choice would seem to weaken democratic process in developing countries limiting the role of public discussion, debate and decision in economic policy-making. And the perceived priority of financial stability over real economy objectives of economic growth and greater employment feed a sense that there are biases in the globalization process and in the international financial institutions which appear to preside over it. As a result, there are strong motivations for exploring the degree of macroeconomic policy choice, both from internal political and economic perspectives and from the point of view of the international debate.

On the Renminbi: The choice between adjustment under a fixed exchange rate

Without capital market imperfections, the capital structure of a firm, including the size, the maturity and the currency composition of debts, should not matter for investment decisions. The Asian financial crises provide a good opportunity to test this hypothesis. We approach the problem in two ways: First, we apply a conventional reduced-form analysis to a panel data of Korean manufacturing firms, argueing that the devaluation that occurred during the crisis provides a natural experiment in which to assess the effect of balance sheet shocks to investment. Second, we use indirect inference to estimate a structural dynamic programming problem of a firm with foreign debts and financial constraints. Both reduced-form evidence and structural parameter estimates imply an important role for finance in investment at the firm level. Counterfactual simulations imply that balance sheet effects may account for 50 % to 80 % of the drop in investment during the crisis period. Although our estimates suggest that foreigndenominated debt had relatively little effect on aggregate investment spending for the Korean economy during this crisis episode, counterfactual experiments imply sizeable contractions in investment through this mechanism for economies that are more heavily dependent on foreign-denominated debt.

This chapter begins by discussing the determinants of the real exchange rate. These are dominated by monetary influences in the short run. But for a country like Kazakhstan, they also include the Balassa-Samuelson effect and the Dutch Disease, especially in the medium and long run. These latter factors suggest the likelihood or pressures toward real appreciation of the tenge in the short and medium run, though it is also important to realize that this trend could reverse in the future. With this as a background, the chapter discusses alternative options for the choice of monetary regime, such as floating exchange rates, fixed exchange rates, and various alternative nominal anchors for monetary policy (including the currently popular regime of inflationtargeting). Two polar cases are rejected, as likely to turn out to be too constraining for Kazakhstan. (The author thus rejects the conventional wisdom of the corners hypothesis, the proposition that intermediate exchange rate regimes are unworkable and countries should easily float freely or peg rigidly.) On the one hand, the economy is too small and open to meet the “optimum currency area ” criteria for a purely floating exchange rate. It is also too much in need of a nominal anchor for monetary policy. While a monetary regime of targeting the CPI while

The views expressed in the HKS Faculty Research Working Paper Series are those of the author(s) and do not

I approach the state of global currency issues by identifying eight concepts that I see as having recently “peaked ” and eight more that I see as currently rising in relevance. Those that I see as having already seen their best days are: the G-7, global savings glut, corners hypothesis, proliferating currency unions, inflation targeting (narrowly defined), exorbitant privilege, Bretton Woods II, and currency manipulation. Those that I see as receiving increased emphasis in the future are: the G-20, the IMF, SDR, credit cycle, reserves, intermediate exchange rate regimes, commodity currencies, and multiple international currency system. In International Monetary Economics our exam questions remain the same over time. Only the answers change, from decade to decade. Although it violates our selfimage as scientists, it is hard to deny that our field has an element of cycles and fads that one associates more often with the financial world or even the fashion world. Currency boards were as popular in the 1990s as they were unknown ten years earlier. And so, with apologies, this lecture is structured in terms of “What’s Hot ” and “What’s Not.”

A new technique for estimating countries ’ de facto exchange rate regimes synthesizes two approaches. One approach estimates the implicit de facto basket weights in an ordinary least squares (OLS) regression of the local currency value rate against major currency values. Here the hypothesis is a basket peg with little flexibility. The second estimates the de facto degree of exchange rate flexibility by observing how exchange market pressure is allowed to show up. Here the hypothesis is an anchor to the dollar or some other single major currency, but with a possibly substantial degree of exchange rate flexibility around that anchor. It is important to have available a technique that can cover both dimensions: inferring anchor weights and the flexibility parameter. We test the synthesis technique on a variety of fixers, floaters, and basket peggers. We find that real world data demand a statistical technique that allows parameters and regimes to shift frequently. Accordingly we estimate de facto exchange rate regimes: endogenous estimation of parameter breakpoints,

Among the characteristics that distinguish most developing countries, compared to the large industrialized countries, are: greater exposure to supply shocks in general and trade volatility in particular, procyclicality of both domestic fiscal policy and international finance, lower credibility with respect to both price stability and default risk, and other imperfect institutions. Models of dynamic inconsistency in monetary policy and the need for central bank independence and commitment to nominal targets apply even more strongly to developing countries. But because most developing countries are price-takers on world markets, the small open economy model, with nontraded goods, is often more useful than the two-country two-good model. Contractionary effects of devaluation are also far more important for developing countries, particularly the balance sheet effects that arise from currency mismatch. The exchange rate was the favored nominal anchor for monetary policy in inflation stabilizations of the late 1980s and early 1990s. After the currency crises of

Fixed and flexible exchange rates each have advantages, and a country has the right to choose the regime suited to its circumstances. Nevertheless, several arguments support the view that China should allow its currency to appreciate. (1) China’s economy in 2004 was on the overheating side of internal balance, and appreciation would help easy inflationary pressure. Although this excess demand probably moderated in 2005, the general principle remains: to achieve both internal balance and external balance simultaneously, an economy needs to be able to adjust its real exchange rate as well as its level of spending. (2) Although foreign exchange reserves are a useful shield against currency crises, by now China’s current level is fully adequate, and US treasury securities do not pay a high return. (3) It becomes increasingly difficult to sterilize the inflow over time. (4) Although external balance could be achieved by increasing expenditure, this policy applied by itself might send China back into the inflationary zone of excess demand. (5) A large economy like China can achieve adjustment in the real exchange rate via flexibility in the nominal exchange rate more easily than via price flexibility. (6) The experience of other emerging markets points toward exiting from a peg when times