Whether the adoption of an inflation targeting (IT) regime reduces exchange rate volatility has been a heated debate and a subject of intense research. On the one hand, exchange rate volatility can be addressed by managing the inflation rate. On the other hand, exchange rate volatility cannot be manipulated by interest rates as the main instrument in the inflation targeting regime. This article aims at examining the impact of inflation targeting regime on exchange rate volatility. Taking the case of Indonesia over the period 2000(1)–2022(12), we found that the targeted inflation lowers inflation rate instability. However, our two-stage generalised autoregressive heteroskedasticity conditional model estimation concludes that inflation volatility induces exchange rate volatility. Accordingly, announcing higher inflation targets may not be costly to reduce inflation uncertainty, resulting in a decline in exchange rate volatility. Furthermore, market intervention can symmetrically mitigate exchange rate volatility. Accordingly, market intervention is needed as an additional instrument for macroeconomic stabilisation. In other words, the optimal stock of foreign reserves (FR) management might avoid Indonesia’s monetary authority to impose dual goals of inflation and exchange rate stability.
AdlerG., ChangK. S., & WangZ. (2021). Patterns of foreign exchange intervention under inflation targeting. Latin American Journal of Central Banking, 2(4), 1–25. https://doi.org/10.1016/j.latcb.2021.100045
2.
AgénorP. R., JacksonT. P., & SilvaL. P. (2020). Foreign exchange intervention and financial stability[BIS working papers no. 889]. BIS.
3.
BanerjeeB., ZemanJ., ÓdorĽ., & RiiskaW. O.Jr. (2018). On the effectiveness of central bank intervention in the foreign exchange market: The case of Slovakia, 1999–2007. Comparative Economic Studies, 60, 442–474. https://doi.org/10.1057/s41294-017-0039-z
4.
BerganzaJ. C., & BrotoC. (2012). Flexible inflation targets, forex interventions, and exchange rate volatility in emerging countries. Journal of International Money and Finance, 31(2), 428–444. https://doi.org/10.1016/j.jimonfin.2011.12.002
5.
BhakriS., & VermaA. (2021). Determinants of foreign exchange reserves in India. International Journal of Research—Granthaalayah, 9(2), 229–240. https://doi.org/10.29121/granthaalayah.v9.i2.2021.3493
CalvoG., & ReinhartC. (2002). Fear of floating. Quarterly Journal of Economics, 117(2), 379–408. https://doi.org/10.1162/003355302753650274
8.
Ca’ZorziM., HahnE., & SánchezM. (2007). Exchange rate pass-through in emerging markets[Working papers no. 739]. European Central Bank.
9.
ChiţuL., & QuintD. (2018). Emerging market vulnerabilities—A comparison with previous crises (Vol. 8). ECB Economic Bulletin, European Central Bank.
10.
ChoudhriE. U., & HakuraD. (2006, June). Exchange rate pass-through to domestic prices: does the inflationary environment matter?. International Journal of Money and Finance, 25(4), 624–639. https://doi.org/10.1016/j.jimonfin.2005.11.009
11.
ComunaleC., & SimolaH. (2018). The pass-through to consumer prices in CIS economies: The role of exchange rates, commodities, and other common factors. Research in International Business and Finance, 44, 186–217. https://doi.org/10.1016/j.ribaf.2017.07.076
12.
DadushU., & StancilB. (2011, May9). Why are reserves so big?VoxEU.org
13.
DaudeC., YeyatiE. L., & NagengastA. (2016). On the effectiveness of exchange rate intervention in emerging markets. Journal of International Money and Finance, 64, 239–261. https://doi.org/10.1016/j.jimonfin.2016.01.004
14.
DomaçI., & MendozaA. (2004, April). Is there room for foreign exchange interventions under an inflation targeting framework? Evidence from Mexico and Turkey[Working paper 3288]. World Bank Group.
15.
DomínguezK. M. E. (2006). When do central bank interventions influence intra-daily and longer exchange rate movements?Journal of International Money and Finance, 25(7), 1051–1071. https://doi.org/10.1016/j.jimonfin.2006.08.009
16.
EbekeC., & AzangueA. F. (2015, October). Inflation targeting and exchange rate regimes in emerging markets[Working paper WP/15/228]. IMF.
17.
EchavarríaJ. J., VasquezD., & VillamizarM. (2010, June). Impact of exchange rate interventions on the level and volatility of the Colombian exchange rate. Ensayos Sobre Politica Economica, 28(62), 12–69.
18.
EdwardsS. (2004). Financial openness, sudden stops, and current account reversals. American Economic Review, 94(2), 59–64. https://doi.org/10.1257/0002828041302217
19.
EngleR. F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica, 50(4), 987–1007. https://doi.org/10.2307/1912773
20.
FermoL. B., & LemenceR. A. E. (2014). Inflation targeting, reserve accumulation, and exchange rate volatility in the Philippines. Bangko Sentral Review, 1–20. https://www.bsp.gov.ph/Media_And_Research/Publications/BS2014_01.pdf
21.
FrenkelM., PierdziochC., & StadtmannG. (2005). The effects of Japanese foreign exchange market interventions on the Yen/U.S. dollar exchange rate volatility. International Review of Economics and Finance, 14(1), 27–39. https://doi.org/10.1016/j.iref.2003.09.003
22.
GagnonJ. E., & IhrigJ. (2004, October). Monetary policy and exchange rate pass-through. International Journal of Finance and Economics, 9(4), 315–338. https://doi.org/10.1002/ijfe.253
23.
GoldbergK., & KnetterM. (1997). Goods prices and exchange rates: What have we learned?Journal of Economic Literature, 35(3), 1243–1292.
24.
GrossmannA., & OrlovA. G. (2022, April). Exchange rate misalignments, capital flows, and volatility. The North American Journal of Economics and Finance, 60, 101640. https://doi.org/10.1016/j.najef.2022.101640
25.
HansenE., & MoralesM. (2019). When does the central bank intervene the foreign exchange market? Estimating a time-varying threshold intervention function. International Review of Finance, 21(5), 1–11. https://doi.org/10.1111/irfi.12288
26.
HeriqbaldiU., WidodoW., & EkowatiD. (2020). Real exchange rate misalignment and currency crises. Bulletin of Indonesian Economic Studies, 56(3), 345–362. https://doi.org/10.1080/00074918.2019.1662885
27.
Insukindro, & SahadewoG. A. (2010). Inflation dynamics in Indonesia: Equilibrium correction and forward-looking Phillips curve approaches. Gadjah Mada International Journal of Business, 12(1), 117–133. https://doi.org/10.22146/gamaijb.5515
28.
JasovaM., MoessnerR., & TakatsE. (2019). Exchange rate pass-through: What has changed since the crisis?International Journal of Central Banking, 15(3), 27–58.
29.
KazdalA., & YılmazM. H. (2021, June). External vulnerabilities and exchange rate pass-through: The case of emerging markets[Working papers 2105]. Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
30.
KearnsJ., & RigobonR. (2005). Identifying the efficacy of central bank interventions: Evidence from Australia and Japan. Journal of International Economics, 66(1), 31–48. https://doi.org/10.1016/j.jinteco.2004.05.001
31.
KruškovićB. D. (2022). Central bank intervention in the inflation targeting. Journal of Central Banking Theory and Practice, 1, 67–85. https://doi.org/10.2478/jcbtp-2022-0003
32.
KuncoroH. (2015). Inflation targeting, exchange rate pass-through, and monetary policy rule in Indonesia. International Journal of Business, Economics and Law, 7(3), 14–25.
33.
KuncoroH. (2020). Interest rate policy and exchange rates volatility, lessons from Indonesia. Journal of Central Banking Theory and Practice, 9(2), 19–42. https://doi.org/10.2478/jcbtp-2020-0012
34.
KuncoroH., & SantosoT. (2022). Re-examining the relative price-exchange rate nexus. Economic Computation and Economic Cybernetics Studies and Research, 56(4), 243–258. https://doi.org/10.24818/18423264/56.4.22.15
35.
LawC. H. (2019). Asymmetric impacts of foreign exchange reserves on the exchange rate in Korea. International Journal of Economics and Business Research, 18(1), 73–93. https://doi.org/10.1504/IJEBR.2019.100652
36.
MinhV. V. (2009). Exchange rate pass-through and its implications for inflation in Vietnam[Working paper no. 0902]. VDF.
37.
MujicaP., & SaensR. (2015, December). Exchange rate pass-through and inflation targets in Chile. CEPAL Review, 117, 137–146.
38.
MuradS. M., & HossainM. A. (2018). The ASEAN experience of the purchasing power parity theory. Financial Innovations, 4(23), 1–10. https://doi.org/10.1186/s40854-018-0113-1
39.
NasirM. A., & VoX. V. (2020). A quarter century of inflation targeting & structural change in exchange rate pass-through: Evidence from the first three movers. Structural Change and Economic Dynamics, 54, 42–61. https://doi.org/10.1016/j.strueco.2020.03.010
40.
NugrohoM. N., Ibrahim, WinarnoT., & PermataM. I. (2014, January). The impact of capital reversal and the threshold of current account deficit on Rupiah. Bulletin of Monetary, Economics and Banking, 16(3), 205–230. https://doi.org/10.21098/bemp.v16i3.445
41.
ObstfeldM., ShambaughJ. C., & TaylorA. M. (2005). The trilemma in history: Tradeoffs among exchange rates, monetary policies, and capital mobility. Review of Economics and Statistics, 87(3), 423–438. https://doi.org/10.1162/0034653054638300
42.
PhamT. A. T., NguyenT. T., NasirM. A., & HuynhT. L. D. (2023, February). Exchange rate pass-through: A comparative analysis of inflation targeting & non-targeting ASEAN-5 countries. Quarterly Review of Economics and Finance, 87, 158–167. https://doi.org/10.1016/j.qref.2020.07.010
43.
PeónS. B. G., & BrindisM. A. R. (2014). Analyzing the exchange rate pass-through in Mexico: Evidence post inflation targeting implementation. Ensayos Sobre Política Económica, 32(74), 18–35. https://doi.org/10.1016/S0120-4483(14)70025-9
44.
Rasbin, IkhsanM., GitaharieB. Y., & AffandiY. (2021). Real exchange rate misalignments: The case of the Indonesian Rupiah. Bulletin of Monetary Economics and Banking, 24(3), 441–464. https://doi.org/10.21098/bemp.v24i3.1268
45.
RazafimahefaF. I. (2012). Exchange rate pass-through in sub-Saharan African economies and its determinants?[Working paper no. WP/12/141]. IMF. https://www.imf.org/external/pubs/ft/wp/2012/wp12141.pdf
46.
RobertsonR., KumarbA., & DutkowskyD. H. (2014, December). Weak-form and strong-form purchasing power parity between the US and Mexico: A panel cointegration investigation. Journal of Macroeconomics, 42, 241–262. https://doi.org/10.1016/j.jmacro.2014.08.005
47.
Sidiq, & HerawatiS. (2016, October). Validity test of purchasing power parity doctrine: An Indonesian case study. Economic Journal of Emerging Market, 8(2), 120–127. https://doi.org/10.20885/ejem.vol8.iss2.art4
48.
SikarwarE. (2020). Forex interventions and exchange rate exposure: Evidence from emerging market firms. Economic Modelling, 93, 69–81. https://doi.org/10.1016/j.econmod.2020.07.010
49.
SteinerA. (2013). The accumulation of foreign exchange by central banks: Fear of capital mobility?Journal of Macroeconomics, 38(B), 409–427. https://doi.org/10.1016/j.jmacro.2013.08.002
50.
SteinerA. (2017). Does the accumulation of international reserves spur inflation. North American Journal of Economics and Finance, 41, 112–132. https://doi.org/10.1016/j.najef.2017.03.007
51.
TaylorJ. B. (2000). Low inflation, pass-through, and the pricing power of firms. European Economic Review, 44(7), 1389–1408. https://doi.org/10.1016/S0014-2921(00)00037-4
52.
TaylorA., & TaylorM. (2004). Purchasing power debate. Journal of Economic Perspectives, 18(4), 135–158. https://doi.org/10.1257/0895330042632744
53.
ToulaboeD. (2017, May). Real exchange rate misalignment of Asian currencies. Asia Pacific Economic Literature, 31(1), 39–52. https://doi.org/10.1111/apel.12173
54.
YeyatiL. E., SturzeneggerF., & GluzmannP. A. (2013). Fear of appreciation. Journal of Development Economics, 101, 233–247. https://doi.org/10.1016/j.jdeveco.2012.11.008
55.
YoonJ. C., MinD. H., & JeiS. Y. (2019, May). Empirical test of purchasing power parity using a time-varying cointegration model for China and the UK. Physica A: Statistical Mechanics and its Applications, 521(1), 41–47. https://doi.org/10.1016/j.physa.2019.01.072
56.
ZhaoY., HaanJ., ScholtensB., & YangH. (2014). Leading indicators of currency crises: Are they the same in different exchange rate regimes?Open Economies Review, 25, 937–957. https://doi.org/10.1007/s11079-014-9315-y
