Exchange rate regimes and real exchange rate volatility: Does inflation targeting help or hurt?

- We examine the impact of inflation targeting (IT) on real exchange rate volatility and its two components.
- This paper compares the effects of inflation targeters and hard peggers.
- The paper accounts for self-selection problem using a matching method.
- IT regimes have greater REER volatility, especially in developed countries.
- The greater volatility of REER in IT developed countries is driven by external prices.

This paper revisits the comparison of the effects of inflation targeters versus hard fixers and intermediate exchange rate regimes. In particular, we are interested in exploring the impact of inflation targeting (IT) on real effective exchange rate (REER) volatility for a panel of 62 developing countries over the period 2006-2012. We also analyze the impact of IT regimes on REER in terms of its two component parts, i.e. relative tradable prices across countries as well as sectoral prices of tradables and nontradables within countries. The paper accounts for self-selection concerns regarding policy adoption and examines the effects of commodity exports and foreign exchange intervention. Notably, IT regimes seem to have experienced greater REER volatility, largely driven by external prices in developed countries. For developing countries, IT regimes show no difference in REER volatility, though there is some evidence that they have lower volatility in internal prices.