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On discretion versus commitment and the role of the direct exchange rate channel in a forward-looking open economy model

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  • Alfred Guender

Abstract

This paper compares optimal monetary policy under discretion and commitment in an economy where the direct exchange rate channel is operative. The stabilization bias under discretion is shown to be weaker in an open economy relative to a closed economy. In an open economy, a 'less conservative central banker', one that attaches a smaller weight to the variance of inflation in the loss function, can be appointed to replicate the behaviour of real output that eventuates under commitment. Evaluating the social loss function under discretion and commitment, we find that the existence of a direct exchange rate channel in the Phillips Curve mitigates the pronounced differences between the two strategies in case of high persistence in the stochastic shocks.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/10168730500199657
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal International Economic Journal.

Volume (Year): 19 (2005)
Issue (Month): 3 ()
Pages: 355-377

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Handle: RePEc:taf:intecj:v:19:y:2005:i:3:p:355-377

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Related research

Keywords: Exchange rate channel; commitment; discretion; stabilization bias;

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References

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  1. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  2. Robert Feenstra & Paul Bergin, 2004. "staggered price setting and endogenous persistence," Working Papers 985, University of California, Davis, Department of Economics.
  3. Froyen, Richard & Guender, Alfred, 2000. "Alternative Monetary Policy Rules for Small Open Economies," Review of International Economics, Wiley Blackwell, vol. 8(4), pages 721-40, November.
  4. Lewis, Mervyn K. & Mizen, Paul D., 2000. "Monetary Economics," OUP Catalogue, Oxford University Press, number 9780198290629.
  5. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
  6. Robert J. Barro & David B. Gordon, 1984. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  7. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
  8. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  9. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
  10. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  11. Stephen J. Turnovsky, 1984. "Wage Indexation and Exchange Market Intervention in a Small Open Economy," NBER Working Papers 1170, National Bureau of Economic Research, Inc.
  12. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  13. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  14. Alfred V. Guender, 2006. "Stabilising Properties of Discretionary Monetary Policies in a Small Open Economy," Economic Journal, Royal Economic Society, vol. 116(508), pages 309-326, 01.
  15. Bennett T. McCallum & Edward Nelson, 2004. "Timeless perspective vs. discretionary monetary policy in forward-looking models," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 43-56.
  16. Marston, Richard C., 1985. "Stabilization policies in open economies," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 17, pages 859-916 Elsevier.
  17. Leitemo, Kai & Roisland, Oistein & Torvik, Ragnar, 2002. " Time Inconsistency and the Exchange Rate Channel of Monetary Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(3), pages 391-97, September.
  18. Richard C. Marston, 1985. "Stabilization Policies in Open Economies," NBER Working Papers 1117, National Bureau of Economic Research, Inc.
  19. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  20. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  21. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
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Citations

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Cited by:
  1. Kirdan Lees, 2003. "The stabilisation problem: the case of New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2003/08, Reserve Bank of New Zealand.
  2. Liu, Philip, 2010. "Stabilization bias for a small open economy: The case of New Zealand," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 921-935, September.
  3. Lees, Kirdan, 2007. "How large are the gains to commitment policy and optimal delegation for New Zealand?," Journal of Macroeconomics, Elsevier, vol. 29(4), pages 959-975, December.

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