Two options for developing economies

According to Czech National Bank Governor Zdenek Tuma, developing economies are faced with two monetary policy options, either fixing their exchange rate to a set currency or adopting an inflation targeting policy, in which a central bank aims to control inflation by adjusting interest rates, an action referred to as “floating.”

“Today we can observe much stronger emphasis on floating in most economies…it’s accepted that inflation targeting is superior to other regimes.”

However, inflation targeting has raised questions, such as whether smaller countries with weaker economies will be able to afford the practice and if it is possible to judge its success when inflation has been low for the past two decades, but Tuma is confident the practice can exceed these concerns.

Tuma discussed the effects of both policies in the Czech Republic. From 1990-1997 the Czech Republic had a fixed exchange rate, and faced skyrocketing inflation rates.

“At that time our predecessors were hesitating between monetary targeting and inflation targeting, and in the end it was inflation targeting and I believe it was the right choice…after ten years we can say that we have managed to introduce very strong credibility of this monetary policy regime and that inflation expectations are pretty well anchored.”

Tuma said an additional benefit of inflation targeting was that it can help mitigate the impact of inflationary shock, something that a fixed exchange rate can not do without making abrupt and often times unsuccessful changes.

Still, Tuma said that choosing the right monetary policy is not the sole factor for success in emerging economies and explained that it is not a substitute for sounds governmental policies.