Exchange Rate Bands and Shifts in the Stabilization Policy Regime: Issues Suggested by the Experience of Colombia

IMF Working Papers, April 1, 1995

Source details

Canonical URL: Exchange Rate Bands and Shifts in the Stabilization Policy Regime: Issues Suggested by the Experience of Colombia

After 25 years, the Colombian authorities decided to abandon the crawling peg exchange rate policy and implement a regime of nominal exchange rate bands.
Initial conditions in Colombia contrast sharply with those of other cases in which bands were part of an ongoing effort to reduce high inflation.
The paper argues that the change in regime was motivated by a change in policy objectives: a shift away from a policy rationale that implied targeting stable inflation.

A simple analytical model of optimal policy is presented, starting from a policy whose rationale implied targeting stable inflation.
The model is used to interpret how a shift in policy objectives can justify moving from a crawling peg to nominal exchange rate bands.

Initial results with the new regime suggest that inflation is now considered costlier.
Policy implementation under the exchange rate bands has been consistent with the view that inflation costs have increased.

Subjects: Crawling peg, Exchange rate policy, Exchange rates, Foreign exchange, Inflation, Prices, Real exchange rates.
Keywords: anti-inflationary policy statement, central bank, Crawling peg, exchange rate band, Exchange rate policy, Exchange rates, government credibility, Inflation, inflation rise, inflation variability, nominal exchange rate, private sector, Real exchange rates, reducing inflation, utility function, WP.