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Is There an Exchange Rate Channel in the Forward-Looking Phillips Curve? A Theoretical and Empirical Investigation

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Abstract

This paper shows how the exchange rate affects the price-setting behavior of monopolistically competitive firms in the sticky price framework that gives rise to a forward-looking Phillips Curve at the aggregate level. The open economy Phillips Curve differs from its closed economy counterpart in that the real exchange rate exerts a direct effect on domestic inflation. The exchange rate channel in the Phillips Curve is pivotal in determining the optimal policy setting in an open economy. On balance, we find only scant empirical evidence for the existence of a direct exchange rate channel in the Phillips Curve in a sample of six OECD countries. Indeed, the forward-looking Phillips Curve does not receive much backing from the data. The use of highly aggregated data may account for the poor fit.

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File URL: http://www.econ.canterbury.ac.nz/RePEc/cbt/econwp/0616.pdf
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Paper provided by University of Canterbury, Department of Economics and Finance in its series Working Papers in Economics with number 06/16.

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Length: 30 pages
Date of creation: 01 Dec 2006
Date of revision:
Handle: RePEc:cbt:econwp:06/16

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Keywords: Open economy Phillips Curve; Exchange rate channel; Output gap;

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Cited by:
  1. Alfred Guender, 2011. "The Timeless Perspective vs. Discretion: Theory and Monetary Policy Implications for an Open Economy," Working Papers in Economics 11/19, University of Canterbury, Department of Economics and Finance.

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