Monetary Policy Under Flexible Exchange Rates: an Introduction to Inflation Targeting

This paper provides an introduction to inflation targeting, with a particular emphasis on analytical issues and the recent experience of developing countries. After presenting a formal framework, it discusses basic requirements for inflation targeting and how such a regime differs from money and exchange rate targeting regimes. The operational framework of inflation targeting (including the price index to monitor, the target horizon, forecasting procedures, and the role of asset prices) is then discussed. Next, recent experiences with inflation targets are examined. The last part of the paper focuses on some current research issues in the literature, including the role of nonlinearities regarding both policy preferences and the slope of the output-inflation tradeoff.), uncertainty (about behavioral parameters and transmission lags), and the treatment of credibility in empirical models of inflation. New evidence on the convexity of the Phillips curve is also provided for six developing countries.