Brazilian Central Bank: Why Fraga chose inflation targeting
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Brazilian Central Bank: Why Fraga chose inflation targeting

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The Brazilian central bank is facing a huge challenge with its decision to make inflation-targeting the cornerstone of monetary policy. With the failure of the previous policy aimed at preserving the exchange rate - which was in place between March 1995 until the real's devaluation in January - it is arguable that the bank under new governor Armínio Fraga had little choice but to go down this road.

The only other serious alternative - targeting monetary aggregates - would be difficult to implement in Brazil because of the high instability of money demand. Yet inflation targeting will hardly be any easier to bring off with the central bank facing a paucity of data on transmission mechanisms. This is needed to help decide what amount of money will feed through to what level of inflation.

Fraga, talking to journalists in London recently, explained why inflation targeting was chosen. "In reality if you are thinking about monetary systems and exchange-rate systems it's really a two step decision. "One is the exchange-rate system you want and what is appropriate for a given country: fixed or floating?"

"If it's fixed then your monetary policy is given by that sole objective of keeping the fixed exchange rate.


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