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Managed Floating as a Monetary Policy Strategy

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  • Peter Bofinger
  • Timo Wollmershäuser

Abstract

Although there seems to be a broad consensus among economists that purely floating or completely fixed exchange rates (the so-called corner solutions) are the only viable alternatives of exchange rate management, many countries do not behave according to this paradigm and adopt a strategy within the broad spectrum of exchange rate regimes that is limited by the two corner solutions. Many of these intermediate regimes are characterized by significant foreign exchange market interventions and a certain degree of exchange rate flexibility with non-preannounced exchange rate targets. While academic research in this area usually concentrates on some specific aspects of intermediate regimes (such as the effectiveness of interventions or institutional aspects), managed floating has rarely been analyzed as a comprehensive monetary policy strategy. In this paper, we present a monetary policy framework in which central banks simultaneously use the exchange rate and the interest rate as operating targets of monetary policy. We explain the mechanics of foreign exchange market interventions and sterilization and we explain why a central bank has an interest of controlling simultaneously the two operating targets. We derive the monetary policy rules for the two operating targets from a simple open economy macro model in which the uncovered interest parity condition and the monetary conditions index play a central role. Copyright Kluwer Academic Publishers 2003

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Bibliographic Info

Article provided by Springer in its journal Economics of Planning.

Volume (Year): 36 (2003)
Issue (Month): 2 (June)
Pages: 81-109

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Handle: RePEc:kap:ecopln:v:36:y:2003:i:2:p:81-109

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Web page: http://www.springerlink.com/link.asp?id=113294

Related research

Keywords: exchange rate regime; floating; interventions; monetary conditions index; monetary policy; sterilization;

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References

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  1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  2. Martin D. D. Evans & Richard K. Lyons, 2003. "Are Different-Currency Assets Imperfect Substitutes?," CESifo Working Paper Series 978, CESifo Group Munich.
  3. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  4. Anna J. Schwartz, 2000. "The Rise and Fall of Foreign Exchange Market Intervention," NBER Working Papers 7751, National Bureau of Economic Research, Inc.
  5. Lars E.O. Svensson, 2002. "Monetary Policy and Real Stabilization," Working Papers 119, Princeton University, Department of Economics, Center for Economic Policy Studies..
  6. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers.
  7. McCallum, Bennett T, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 870-904, November.
  8. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  9. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  10. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  11. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  12. Jorge Iván Canales Kriljenko, 2003. "Foreign Exchange Intervention in Developing and Transition Economies," IMF Working Papers 03/95, International Monetary Fund.
  13. Bofinger, Peter & Wollmershäuser, Timo, 2001. "Managed floating: Understanding the new international monetary order," W.E.P. - Würzburg Economic Papers 30, University of Würzburg, Chair for Monetary Policy and International Economics.
  14. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
  15. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  16. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March.
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Citations

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Cited by:
  1. Drakopoulos, Stavros A. & Karayiannis, Anastassios, 2005. "A Review of Kuhnian and Lakatosian “Explanations” in Economics," MPRA Paper 16624, University Library of Munich, Germany.
  2. Marjan Petreski, 2012. "Output Volatility and Exchange Rate Considerations Under Inflation Targeting : A Review," International Journal of Economics and Financial Issues, Econjournals, vol. 2(4), pages 528-537.
  3. Eduardo Ariel Corso, 2007. "Monetary Space in Latin America: A Criterion to Regime Selection," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(48), pages 111-144, July - Se.
  4. Damill, Mario & Frenkel, Roberto, 2012. "Macroeconomic Policies, Growth, Employment, and Inequality in Latin America," Working Paper Series UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  5. Enrique Alberola & José María Serena, 2007. "Global financial integration, monetary policy and reserve accumulation. Assessing the limits in emerging economies," Banco de Espa�a Working Papers 0706, Banco de Espa�a.
  6. Renzo Rossini & Marco Vega, 2007. "The monetary policy transmission mechanism under financial dollarization: the case of Peru 1996-2006," Working Papers 2007-017, Banco Central de Reserva del Perú.
  7. Hernando Vargas H., 2005. "Política cambiaria y la fijación de metas inflacionarias en Colombia," Research Department Publications 4426, Inter-American Development Bank, Research Department.
  8. Hernández Monsalve, Mauricio Alberto & Mesa Callejas, Ramón Javier, 2006. "El efecto de las intervenciones cambiarias: la experiencia colombiana 2004-2006," MPRA Paper 942, University Library of Munich, Germany, revised Oct 2006.
  9. Roberto Chang, . "Inflation Targeting, Reserves Accumulation, and Exchange Rate Management in Latin America," Borradores de Economia 487, Banco de la Republica de Colombia.
  10. Rossini, Renzo & Vega, Marco, 2007. "El mecanismo de transmisión de la política monetaria en un entorno de dolarización financiera: El caso del Perú entre 1996 y 2006," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 14, pages 11-32.
  11. Hiroya Akiba & Yukihiro Iida & Yoshihiro Kitamura, 2009. "The optimal exchange rate regime for a small country," International Economics and Economic Policy, Springer, vol. 6(3), pages 315-343, October.
  12. Mariano Beltrani & Juan Cuattromo, 2012. "Redefining Monetary Policy Limits: Towards an Expansion of its Role in Economic Development," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(67), pages 121-168, December.
  13. Hernando Vargas H., 2005. "Exchange Rate Policy and Inflation Targeting in Colombia," Research Department Publications 4425, Inter-American Development Bank, Research Department.

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