Choice of monetary policy in developing countries

The Asian crisis of the 1990s brought into question the adequacy of intermediate exchange rate regimes for developing countries. The alternatives suggested by the literature are fixed exchange rates and inflation targeting. In Chapter 2 I find that developing countries that target inflation tend to have economies that are more developed (a higher share of industry and services to GDP), are less open to trade and have more diversified exports compared with developing countries that do not target inflation. Controlling for these variables, adoption of inflation targeting (IT) is not related to central bank independence, GDP/capita, fiscal dominance and average inflation rates. Developing countries that had low inflation rates before IT adoption also had lower fiscal dominance and higher financial depth. Post-IT adoption, all developing countries experienced decreases in inflation rates, but targeters had larger decreases in inflation rates. After controlling for factors historically associated with low inflation rates (such as fiscal dominance and financial depth), as well as initial inflation rates (to control for reversion to the mean), central bank independence and degree of openness to trade, I found that the choice of inflation targeting helped decrease inflation rates in developing IT-ers. In Chapter 3 I use a multinomial logit model of monetary policy choice between hard pegs, inflation targeting, and "neither hard pegs nor inflation targeting", and I find that countries that are less open to trade, more developed, have more diversified exports and have more independent central banks relative to the countries in "neither" category are more likely to be inflation targeters, while countries that are more developed and have less actual central bank independence than those in the reference group are more likely to be hard pegs. Fiscal dominance is not associated with the choice of monetary policy.