Inflation Targeting and the Exchange Rate in an Open Economy

Since 1998 Poland has applied the inflation targeting system of monetary policy. This paper reviews briefly the basic features of such type of monetary policy. The main purpose is to discuss the influence of such policy on the changes of foreign exchange rates. Our baseline framework is a standard general equilibrium model with money and temporary nominal price rigidities extended to the open economy context. We applied also the graphical interpretation of this model. We focus on the influence of monetary policy during transition to low inflation on the developments of foreign exchange rates and their potential consequences. Especially we discuss these consequences for less developed countries providing brief comments on the influence of anti-inflationary policy on the rate of exchange of Polish currency. Then we analyze the influence of specific shocks and the best responses of monetary policy. We ends with focusing on main conclusions stemming from our analysis