Balance of Payments Crises Under Inflation Targeting

This paper analyzes a small open economy model under inflation targeting. It shows why such a monetary regime is vulnerable to speculative attacks that take place over a short period rather than instantaneously. The speed at which the regime collapses, and the extent of reserve losses, are increasing in the central bank''s explicit or implicit commitment to intervene in the foreign exchange market. Attacks are therefore ranked, from most to least severe, as follows: Exchange rate targeting, CPI inflation targeting, domestic nontradables inflation targeting, and money targeting. Under inflation targeting the size of the attack is increasing in the tradables consumption share.Inflation targeting;Economic models;inflation, exchange rate, foreign exchange, exchange rate targeting, exchange rate depreciation, monetary policy, inflation target, foreign exchange reserves, exchange reserves, real money, money supply, relative price, nominal exchange rate, nominal interest rate, foreign exchange market, inflation rate, price level, real variables, foreign currency, nominal interest rates, inflation rates, exchange rates, inflation targeting regime, exchange rate volatility, inflation stabilization, inflation tax, exchange rate pass, flexible exchange rate, real exchange rate, flexible exchange rates, annual inflation, exchange rate regime, exchange rate target, inflationary consequences, nominal exchange rate depreciation, flexible exchange rate ? regime, exchange rate instability, floating exchange rate, floating exchange rate regime, nominal rate of return, exchange rate pressures, flexible exchange rate regime, exchange rate policy, nominal exchange rates, exchange rate changes, monetary aggregate, real interest rate, real exchange rate depreciation, monetary base, real exchange rate volatility, floating exchange rates, exchange rate ? regime, exchange rate rule, currency depreciation, fixed exchange rate