Beyond bipolar: A three-dimensional assessment of monetary frameworks

A great deal of attention has been focused recently on the impact of exchan ge rate regimes, just as previous empirical research examined central bank autonomy and announced targets for domestic monetary policy. To date, howev er, these three elements of monetary frameworks have been assessed in isola tion from one another, and all have been viewed in terms of a unidimensiona l spectrum of fixity versus flexibility. Using a newly constructed dataset, this paper jointly analyses and compares all three elements' effects on in flation and exchange rate behaviour. The results show that each of the thre e elements has independent and distinct effects on nominal outcomes. Key fi ndings include: (1) although hard pegs do tend to reduce inflation and atte nuate exchange rate fluctuations within some range, they are clearly charac terized by large devaluations (2) central bank autonomy is associated with a more stable exchange rate and lower inflation; and (3) explicit inflation targeting reduces both inflation and its persistence, consistent with the view that inflation targeting increases flexibility through transparency. T hese results raise the possibility that a combination of central bank auton omy, inflation targeting, and a free float might offer the same benefits as any intermediate exchange rate regime on its own, without the proclivity t o occasional large depreciations. Copyright (C) 2001 Institute for Internat ional Economics and Federal Reserve Bank of New York.