Exchange rates, inflation and monetary policy objectives in open economies: the experience of Chile

There is some evidence, however, that central banks in emerging economies use the interest rate to avoid exchange rate fluctuations. In fact, Calvo and Reinhart (2002), concluded that in some countries interest rate and exchange rate move in the same direction; depreciations in the exchange rate (domestic price of foreign currency) generate an increase in the interest rate controlled by the central bank. Furthermore, they argue that interest rate policy is replacing foreign exchange intervention as the preferred means of smoothing exchange rate fluctuations. According to this view monetary authorities try to stabilize the exchange rate, even if they claim to have a flexible exchange rate system.