The special challenges faced by central banks in emerging market economies in conducting monetary policy are examined. In addition to sharing the same problems confronted by their counterparts in advanced economies – including most profoundly time inconsistency and model uncertainty – they encounter more shocks emanating from the external environment, due to their relatively small economic size. In this context, the exchange rate and the management of capital flows take on a heightened importance. Overarching these concerns is the fact that most emerging markets, by definition, are characterized by less well developed financial markets that constrain and complicate the conduct of monetary policy. These points are illustrated by reference to a description of the evolution of (i) emerging market economies choices with regard to the international trilemma, (ii) the implementation of monetary policy, and (iii) the accumulation of foreign exchange reserves.
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