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The exchange rate and optimal monetary policy rules in open and developing economies: Some simple analytics

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  • Cavoli, Tony
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    Abstract

    Using a simple, tractable model, this paper revisits and expands upon issues relating to optimal monetary policy rules (MPRs) in open economies. The optimality of the rule is explored through various specifications of a central bank loss function as it is the loss function that offers insight into central bank preferences. Many of the issues on this topic have centred on the role of the exchange rate: Is it optimal for the policy instrument to react to the exchange rate? What is the role of the exchange rate in a domestic inflation targeting vs CPI inflation targeting? Does a fear of floating have any bearing on the way optimal MPRs are constructed? While this paper is not empirical, the analysis is relevant for central banks in open and developing economies that face a choice between allowing exchange rates to float (and adopting an inflation targeting regime) and engaging in some degree of exchange rate fixity.

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    Bibliographic Info

    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 25 (2008)
    Issue (Month): 5 (September)
    Pages: 1011-1021

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    Handle: RePEc:eee:ecmode:v:25:y:2008:i:5:p:1011-1021

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    Web page: http://www.elsevier.com/locate/inca/30411

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    Cited by:
    1. Marc Pourroy, 2013. "Inflation-Targeting and Foreign Exchange Interventions in Emerging Economies," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00881359, HAL.
    2. Berganza, Juan Carlos & Broto, Carmen, 2011. "Flexible inflation targets, forex interventions and exchange rate volatility in emerging countries," BOFIT Discussion Papers 9/2011, Bank of Finland, Institute for Economies in Transition.
    3. Bask, Mikael, 2011. "A Case for Interest Rate Inertia in Monetary Policy," Working Paper Series 2011:16, Uppsala University, Department of Economics.
    4. Cavoli, Tony, 2010. "What Drives Monetary Policy in Post-Crisis East Asia? Interest Rate or Exchange Rate Monetary Policy Rules," Journal of Asian Economics, Elsevier, vol. 21(5), pages 456-465, October.

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