Challenges in the Era of Globalization - iaabd

Proceedings of the 12th Annual Conference © 2011 IAABD
industrialization process of these poor and small countries by undercutting their competitiveness of the
domestic industries. Hence, there is a slow pace of industrialization and asset price boom in non-tradable
items.
The management of the exchange rate and the capital account of the balance of payments is a key support
of an investment –driven strategy. Macroeconomic policies across these countries during the last decades
have been influenced by the recommendations of the international financial institutions and bilateral aid
donors. The empirical results of these policies are not suggestive of equitable growth compared to the
growth stories in other parts of the world. In a free floating economy, the continuous depreciation of
domestic currency implies a fall in the real wage. The income distribution measures in the depreciation
case indicate that due to increases in the CPI, all factors loose purchasing power.
The current orthodoxy of freely floating rates combined with monetary policy focused on inflation targets
is often correlated with exchange rate volatility of the kind that undermines domestic macroeconomic
stabilization efforts. In view of the current macroeconomic challenges of globalization, the consistency of
the exchange rate policy to macroeconomic objectives needs to be re-examined. Hence, there is a clear
case for revisiting the inflation targeting .The inflation targeting approach has many assumptions such as
reliable forecast for inflation; efficient financial market; complete industrialization and high market
credibility. It is also dependent on the degree of independence of central banks and their financial
strength. A depreciating exchange rate can only support or increase the net exports if there is idle
capacity and the industrial infrastructure is in place.
With this preamble, this paper explores the possibility of exchange rate targeting as an anchor of
development policy instrument in Uganda. The paper is organized as follows. Section 1 gives an
overview of the recent developments in the literature. Section 2 does the analysis of economic data to
support the basis of the hypothesis of the paper .Section 3 provides the tentative interpretation and policy
implication. The last section concludes with further scope of the study.
Recent Development in the Related Literature
A literary survey of neoclassical theories suggests that the nominal exchange rate can serve as a nominal
anchor for macroeconomic stability in the long run. Gill Hammond et al (2009) say that monetary policy
is typically the first line of defense against a number of internal and external shocks. The study further
suggests that country specific circumstances and internal initial conditions mater a great deal in dealing
the issue of appropriate monetary policy framework. The study concludes that for economies that are
highly open to trade, high nominal exchange rate volatility complicates domestic macroeconomic
management and can have adverse effects on investment, employment and output growth. The stable
exchange rate is welfare improving from a purely domestic point of view. The experience of Tunisia, a
small and open economy, as a country that has adopted exchange rate targeting, is quite encouraging.
Recent studies on the role exchange rate in the monetary policy framework and the role of exchange rate
on economic growth have found positive relationship between economic growth and stable exchange rate
regimes.
Gunther Schnabl (2007) argues that for small open economies in the economic- catch-up process, fixed
exchange rates provide a more stable environment for the adjustment of asset and labor markets. Huang
and Malhotra (2004) findings suggest that fixed and managed float outperform floating exchange rate
regime in terms of growth in developing economies. The most inspiring study on the subject is one by
Eichengreen (2008). The study concludes that the exchange rate policy is an important enabling
condition for the economic growth; that maintaining the exchange rate at competitive levels and avoiding
excessive volatility are important factors to capitalize on disciplined labor force for rapid industrialization
and creating an investment friendly climate.
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