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December 2000
This paper evaluates the performance of exchange rate, inflation and money targeting under terms of trade, real interest rate, foreign inflation and money demand shocks. Inflation targeting must target the price level as opposed to forward looking inflation for uniqueness of perfect foresight equilibria. Its performance is very similar to exchange rate targeting. Money targeting displays real exchange rate flexibility in response to foreign shocks, while exchange rate and inflation targeting permit accommodation of money demand shocks. Because of distortions temporary output booms are generally welfare improving, which makes welfare rankings among policies dependent on the direction of shocks