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Exchange Rate Targeting in a Small Open Economy

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Author Info
Mette Ersbak Bang Nielsen ()
Abstract

The paper develops a New Keynesian Small Open Economy Model charac- terized by external habit formation and Calvo price setting with dynamic inflation updating. The model is used to analyze the e¤ect of nominal ex- change rate targeting on optimal policy and impulse responses. It is found that even moderate exchange rate concerns are capable of changing both sign and magnitude of the optimal instrument response to variables, and that whether the concern is with respect to the level or first di¤erence has much impact on monetary policy. Also, the cost of exchange rate stabilization in terms of output and inflation is evident in the model, and impulse responses under moderate exchange rate targeting are not simple combinations of those under a float and a regime that cares almost only for meeting the exchange rate target.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 367.

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Handle: RePEc:bdr:borrec:367

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Related research
Keywords: Flexible inflation targeting; exchange rates; fear of floating;

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Moron, Eduardo & Winkelried, Diego, 2005. "Monetary policy rules for financially vulnerable economies," Journal of Development Economics, Elsevier, vol. 76(1), pages 23-51, February. [Downloadable!] (restricted)
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  3. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Alessandro Flamini, 2003. "CPI Inflation Targeting and Exchange Rate Pass-through," Macroeconomics 0306017, EconWPA. [Downloadable!]
  6. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
  7. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    Other versions:
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