in: Frank Rövekamp / Moritz Bälz / Hanns Günther Hilpert (eds), Central banking and financial stability in East Asia, Heidelberg: Springer, 157-167
Inflation targeting (IT) arrangements rose to prominence in the early 1990s, when a couple of advanced countries adopted IT as their formal monetary policy framework. Over the years, IT arrangements have also been implement by a growing number of emerging economies, including Korea, Indonesia, Thailand and the Philippines, all of which adopted IT frameworks soon after the Asian crisis. Although formally following IT regimes, the central banks of these four countries have continued to manage their exchange rates against the dollar. While generally low inflation rates during the period of “great moderation” made inflation targeting a relatively easy job and gave central banks leeway to manage exchange rates without compromising their inflation targets, there have been episodes during which conflicts arose between explicit internal inflation targets and informal external exchange rate targets. Conflict, however, may not only arise between inflation and exchange-rate targeting, but also when taking into account the nexus between monetary policy and financial stability. After the Global Financial Crisis clearly exposed the problems that can arise for financial stability when central banks focus too narrowly on inflation rates, a consensus is currently emerging that central banks ought to include financial stability in their policy reaction functions. Against this backdrop, the chapter discusses the trilemma faced by East Asian central banks in targeting inflation rates while at the same time guarding financial market stability and managing exchange rates. It reviews the experience of East Asian countries with inflation targeting to date and discusses the challenges for incorporating macroprudential regulation into monetary policy frameworks while keeping an eye on the exchange rate.