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

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References

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  1. 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.
  2. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  3. Bennett T. McCallum & Edward Nelson, 2000. "Timeless Perspectives vs. Discretionary Monetary Policy In Forward-Looking Models," NBER Working Papers 7915, National Bureau of Economic Research, Inc.
  4. 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.
  5. 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.
  6. 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.
  7. Robert Feenstra & Paul Bergin, 2004. "staggered price setting and endogenous persistence," Working Papers 985, University of California, Davis, Department of Economics.
  8. 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.
  9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  10. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  11. Bennett T. McCallum, 1983. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
  12. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  13. 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.
  14. 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.
  15. 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.
  16. Lewis, Mervyn K. & Mizen, Paul D., 2000. "Monetary Economics," OUP Catalogue, Oxford University Press, number 9780198290629.
  17. 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.
  18. Richard C. Marston, 1985. "Stabilization Policies in Open Economies," NBER Working Papers 1117, National Bureau of Economic Research, Inc.
  19. 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.
  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.
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Citations

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Cited by:
  1. 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.
  2. 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.
  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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