Inflation targeting, exchange rate volatility and international policy coordination

Abstract

In a linear rational expectations two-country model, using an ag- gregate demand, aggregate supply framework, we analyse the ejects of the adoption of an inflation targeting regime on exchange rate volatility and the possible scope for policy oordination. This analysis is conducted using optimized interest rate policy rules within a calibrated model. Rules for interest rates that respond either to exchange rates or to portfolio hocks give improved performance and permit gains from international coordination. Optimized aylor rules perform relatively well.