In a linear rational expectations two-country model, using an
aggregate demand-aggregate supply framework, we analyze the effects of the adoption of an
inflation targeting regime on exchange rate volatility and the possible scope for policy
coordination. This analysis is conducted using optimized interest rate policy rules within
a calibrated model. Rules for interest rates that respond either to exchange rates or to
portfolio shocks give improved performance and permit gains from international
coordination. Optimized Taylor Rules perform relatively well.
JEL Classification: E17; E52; E61; F42.
Keywords: Inflation Targeting; Taylor Rule; Exchange Rate
Coordination; Rational Expectations.