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A DSGE model for a SOE with systematic interest and foreign exchange policies in which policymakers exploit the risk premium for stabilization purposes

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  • Escudé, Guillermo J.

Abstract

This paper builds a DSGE model for a small open economy (SOE) in which the central bank intervenes the domestic currency bond and FX markets using two policy rules: a Taylor-type rule and a rule that determines the rate of nominal depreciation. The 2 'corner' regimes, in which only one policy rule is used, are particular cases. The model is calibrated and implemented in Dynare for simple and optimal simple policy rules, and optimal policy under commitment. Numerical losses are obtained for ad-hoc loss functions for different sets of central bank preferences. The results show that the losses are lower when both policy rules are used. This is due to the central bank's enhanced ability, when it uses the two policy rules, to influence private capital flows through the effects of its actions on the endogenous risk premium in the risk-adjusted uncovered interest parity equation.

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  • Escudé, Guillermo J., 2013. "A DSGE model for a SOE with systematic interest and foreign exchange policies in which policymakers exploit the risk premium for stabilization purposes," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 7, pages 1-110.
    • Handle: RePEc:zbw:ifweej:201330
    DOI: 10.5018/economics-ejournal.ja.2013-30
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    Cited by:

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    2. Escudé, Guillermo J., 2014. "The possible trinity: Optimal interest rate, exchange rate, and taxes on capital flows in a DSGE model for a small open economy," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 8, pages 1-58.
    3. Vitaly Orlov, 2018. "Solvency Risk Premia and the Carry Trades," Working Papers on Finance 1802, University of St. Gallen, School of Finance.
    4. Zdzienicka, Aleksandra, 2022. "Managing External Volatility: Policy Frameworks in Non-Reserve-Issuing Economies," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 4(3), pages 60-98, April.
    5. Boniface Pepino Yemba, 2017. "Tax and monetary policy rules in a small open economy with disaggregated government purchases," International Journal of Monetary Economics and Finance, Inderscience Enterprises Ltd, vol. 10(2), pages 144-182.
    6. Shulgin, Andrei, 2014. "How much monetary policy rules do we need to estimate DSGE model for Russia?," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 36(4), pages 3-31.
    7. Shulgin, A., 2015. "Optimization of Simple Monetary Policy Rules on the Base of Estimated DSGE-model," Journal of the New Economic Association, New Economic Association, vol. 26(2), pages 64-98.
    8. Shulgin, A., 2017. "Two-Dimensional Monetary Policy Shocks in DSGE-Model Estimated for Russia," Journal of the New Economic Association, New Economic Association, vol. 33(1), pages 75-115.
    9. Tai‐kuang Ho & Ya‐chi Lin & Kuo‐chun Yeh, 2021. "The case for starting a new exchange rate after debt settlement: Reexamining alternatives to Argentina’s exchange rate policy in 2001–2002," Review of International Economics, Wiley Blackwell, vol. 29(3), pages 641-662, August.
    10. Andrei G. Shulgin, 2018. "Monetary Regime Choice and Optimal Credit Rationing at the Official Rate: The Case of Russia," International Economic Journal, Taylor & Francis Journals, vol. 32(4), pages 631-668, October.
    11. Nikolay P. Pilnik & Malika F. Shaikhutdinova, 2017. "Modeling of the Balance of Payments State in Russia," Finansovyj žhurnal — Financial Journal, Financial Research Institute, Moscow 125375, Russia, issue 5, pages 84-101, October.

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    More about this item

    Keywords

    DSGE models; small open economy; exchange rate policy; optimal policy;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy

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