Exchange Rates and Monetary Policy in Open Economies: The Experience of Chile in the Nineties
AbstractThis paper provides an empirical characterization of the conduct of monetary policy in a small open economy. In particular, using as a case study the Chilean inflation-targeting experience of the nineties, we assess the roles of the exchange rate and output in the determination of the policy interest rate. We conclude that Chile adopted a gradual approach to targeting inflation. This means, in practice, that the central bank modified its policy instrument —the interest rate— whenever expected inflation deviated from its target, but with some concern about output. In this context, we find evidence that the monetary authorities also reacted to real exchange rate misalignments. This reaction was comparatively larger than the one found in developed economies. Finally, the evidence, although not conclusive, suggests that there was a non-linear response to exchange rate misalignments: the central bank reacted more strongly to large deviations than to small ones.
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Bibliographic InfoPaper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 272.
Date of creation: Oct 2004
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-CBA-2004-11-07 (Central Banking)
- NEP-HIS-2004-11-07 (Business, Economic & Financial History)
- NEP-IFN-2004-11-07 (International Finance)
- NEP-MAC-2004-11-07 (Macroeconomics)
- NEP-MON-2004-11-07 (Monetary Economics)
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