The Case for a Managed Float under Inflation Targeting

By Jonathan D. Ostry

(Version in Español)

The global financial crisis has reminded emerging market economies, if they needed reminding, that capital flows can be highly volatile and that crises need not be home grown.

Emerging markets have been affected in a variety of ways, not least by the sharp ups and downs in exchange rates that volatile capital flows engender.

These ups and downs may be less benign in emerging markets than they might be in advanced economies for a number of reasons.

• First, emerging markets may have more fragile balance sheets—essentially they are less well hedged against currency risk—so depreciations may engender financial distress and even bankruptcies and adverse effects on economic activity.
• Second, they may be less flexible, so that when the exchange rate strengthens and the traded goods sector loses competitiveness, this may have permanent effects on the economy even if the exchange rate later reverts to its initial level.