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Exchange Rates and Monetary Policy in Open Economies: The Experience of Chile in the Nineties

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Rodrigo Caputo

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Abstract

This 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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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 272.

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Date of creation: Oct 2004
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Handle: RePEc:chb:bcchwp:272

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Clarida, Richard H, 2001. "The Empirics of Monetary Policy Rules in Open Economies," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(4), pages 315-23, October. [Downloadable!] (restricted)
  2. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen. [Downloadable!] (restricted)
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  3. Harvey, A C & Jaeger, A, 1993. "Detrending, Stylized Facts and the Business Cycle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(3), pages 231-47, July-Sept. [Downloadable!] (restricted)
  4. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May. [Downloadable!] (restricted)
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  5. Taylor, John B., 1998. "The Robustness and Efficiency of Monetary Policy Rules as Guidelines for Interest Rate Setting by the European Central Bank," Seminar Papers 649, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  6. Eric Parrado, 2004. "Inflation Targeting and Exchange Rate Rules in an Open Economy," IMF Working Papers 04/21, International Monetary Fund. [Downloadable!]
  7. Favero, Carlo A. & Scott, Alasdair, 2003. "Applied Macroeconometrics," Macroeconomic Dynamics, Cambridge University Press, vol. 7(02), pages 313-315, April. [Downloadable!]
  8. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
  9. Eric Parrado & Andrés Velasco, 2001. "Alternative Monetary Rules in the Open-Economy: a Welfare-Based Approach," Working Papers Central Bank of Chile 129, Central Bank of Chile. [Downloadable!]
  10. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May. [Downloadable!] (restricted)
  11. Andrew Harvey, 2002. "Trends, Cycles and Convergence," Working Papers Central Bank of Chile 155, Central Bank of Chile. [Downloadable!]
  12. Vitale, Paolo, 2003. "Foreign exchange intervention: how to signal policy objectives and stabilise the economy," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 841-870, May. [Downloadable!] (restricted)
  13. Richard Clarida, 2001. "The Empirics of Monetary Policy Rules in Open Economies," NBER Working Papers 8603, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  1. Marcelo Sánchez, 2005. "The link between interest rates and exchange rates - do contractionary depreciations make a difference?," Working Paper Series 548, European Central Bank. [Downloadable!]
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