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Optimal MOnetary Policy Rules when the Current Account Matters

In: Monetary Policy: Rules and Transmission Mechanisms

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  • Juan Pablo Medina

    (Banco Central de Chile)

  • Rodrigo O. Valdés

    (International Monetary Fund)

Abstract

This paper explores the implications for optimal monetary policy rules of including a target for the current account (CA) among central bank (CB) objectives. Using a simple but realistic macroeconomic model of the Chilean economy and standard dynamic programming with forward looking variables, the paper finds optimal rules under alternative specifications of a CB quadratic loss-function. The results show that optimal policy reactions change substantially when there is an objective for the CA (besides inflation). Furthermore, once the CA enters the CB objective function, the relative importance of output vis-à-vis inflation variability is less crucial in determining optimal policy rules. Using a simple 2-equation model, the paper then investigates the implications for monetary policy of having an asymmetric objective with respect to the CA. Specifically, it considers the case in which negative deviations from target are considered to be relatively more costly. The results indicate that, in this non-quadratic set-up, monetary policy is clearly more aggressive against positive inflation shocks than in the symmetric case.

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Bibliographic Info

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This chapter was published in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Monetary Policy: Rules and Transmission Mechanisms, , chapter 4, pages 047-064, 2002.

This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v04c04pp065-094.

Handle: RePEc:chb:bcchsb:v04c04pp065-094

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  1. Medina, J.P. & Valdes, R., 2000. "Optimal Monetary Policy Rules Under Inflation Range Targeting," Papers 61, Cambridge - Risk, Information & Quantity Signals.
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Citations

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Cited by:
  1. Juan Pablo Medina & Anella Munro & Claudio Soto, 2008. "What drives the current account in commodity exporting countries? The cases of Chile and New Zealand," BIS Working Papers 247, Bank for International Settlements.
  2. Bohl, Martin T. & Siklos, Pierre L., 2005. "The Role of Asset Prices in Euro Area Monetary Policy: Specification and Estimation of Policy Rules and Implications for the European Central Bank," Working Paper Series 2005,6, European University Viadrina Frankfurt (Oder), The Postgraduate Research Programme Capital Markets and Finance in the Enlarged Europe.
  3. Pierre L. Siklos & Martin T. Bohl, 2007. "Asset Prices as Indicators of Euro Area Monetary Policy: An Empirical Assessment of Their Role in a Taylor Rule," Working Paper Series 32-07, The Rimini Centre for Economic Analysis, revised Jul 2007.
  4. Francisco Rosende, 2002. "La Nueva Síntesis Keynesiana: Análisis e Implicancias de Política Monetaria," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 39(117), pages 203-233.
  5. Rodrigo Caputo & Felipe Liendo & Juan Pablo Medina, 2006. "New Keynesian Models For Chile During The Inflation Targeting Regime: A Structural Approach," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 9(3), pages 73-95, December.
  6. Claudio Soto, 2003. "Monetary Policy, Real Exchange Rate, and the Current Account in a Small Open Economy," Working Papers Central Bank of Chile 253, Central Bank of Chile.

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