Foreign monetary policy and domestic inflation in emerging markets

We estimate the response of domestic inflation to a US interest rate shock in a sample of 27 emerging economies, using local projection methods. Our results point out that the sign of the inflation response crucially depends on the monetary policy framework: after a US monetary policy tightening, inflation decreases in peggers; inflation increases in floaters that do not target inflation; the inflation response is not statistically different from zero in floaters that are committed to an inflation target. We rationalize this outcome using a standard DSGE model. We show that pegging the exchange rate yields larger welfare losses compared to the other two monetary policy frameworks, even assuming dominant currency pricing