Inflation Targeting in ASEAN-10

The paper addresses the empirical question of whether economies that do not systematically target inflation (non-inflation targeters) experience higher exchange rate volatility as compared with inflation targeters in 10 countries of the Association of Southeast Asian Nation (ASEAN) from 1990 to 2010. The paper examines the role of real exchange rate, exchange rate volatility and the reaction functions of central banks using dynamic panel estimation techniques. The results indicate that the output gap offers more useful information than the inflation gap in setting interest rates for inflation targeters, implying that the real term is more important than the nominal term. In turn, this suggests that an increase in interest rate can be wielded swiftly to reduce real gross domestic product and suppress inflation. The real exchange rate appears as a weaker determinant in setting interest rates for non-inflation targeters. Inflation targeters experienced lower exchange rate volatility compared with non-targeters in the ASEAN, which implies that implementation costs to their domestic economies may be marginally lower. Meanwhile, the non-targeters follow a mixed strategy as both the inflation and real exchange rate are used as instruments to set the interest rates.