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Policy Rules and External Shocks

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Author Info
Laurence Ball

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Abstract

This essay discusses rules for monetary policy in open economies. If policymakers seek to stabilize output and inflation, optimal rules in open economies differ considerably from optimal rules in closed economies. In open economies, stability is best achieved by targeting long-run inflation, a measure of inflation adjusted to remove transitory effects of exchange-rate movements. Stability is also enhanced by adding an exchange-rate term to "Taylor rules" for setting interest rates. Finally, central banks must choose whether their policy instrument is an interest rate or a "monetary conditions index": an average of the interest rate and the exchange rate. The nature of shocks to the exchange rate determines which of these choices keeps output and inflation more stable.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 82.

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Date of creation: Oct 2000
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Handle: RePEc:chb:bcchwp:82

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  1. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia. [Downloadable!]
  2. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc. [Downloadable!]
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  1. Katerina Smidkova, 2003. "Targeting Inflation under Uncertainty: Policy Makers’ Perspective," Macroeconomics 0304003, EconWPA. [Downloadable!]
    Other versions:
  2. Efrem Castelnuovo, 2004. "Regime Shifts and the Stability of Backward Looking Phillips Curves in Open Economies," Computing in Economics and Finance 2004 49, Society for Computational Economics. [Downloadable!]
    Other versions:
  3. Reginaldo P. Nogueira Jnr, 2006. "Inflation Targeting, Exchange Rate Pass-Through and 'Fear of Floating'," Studies in Economics 0605, Department of Economics, University of Kent. [Downloadable!]
  4. Reginaldo P. Nogueira Jnr, 2006. "Inflation Targeting and the Role of Exchange Rate Pass-through," Studies in Economics 0602, Department of Economics, University of Kent. [Downloadable!]
  5. Mandler, Martin, 2006. "Are there gains from including monetary aggregates and stock market indices in the monetary policy reaction function? A simulation study of recent U.S. monetary policy," MPRA Paper 2318, University Library of Munich, Germany. [Downloadable!]
  6. Carlos Fernando Lagrota R. Lopes, 2004. "Monetary Policy And External Vulnerability In Brazil," Anais do XXXII Encontro Nacional de Economia [Proceedings of the 32th Brazilian Economics Meeting] 071, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics]. [Downloadable!]
  7. Marcel Fratzscher, 2002. "The Euro bloc, the Dollar bloc and the Yen bloc: how much monetary policy independence can exchange rate flexibility buy in an interdependent world?," Working Paper Series 154, European Central Bank. [Downloadable!]
  8. Mardi Dungey, 2001. "International Shocks and the Role of Domestic Policy in Australia," CEPR Discussion Papers 443, Centre for Economic Policy Research, Research School of Social Sciences, Australian National University. [Downloadable!]
    Other versions:
  9. Sek, Siok Kun, 2008. "Interactions between monetary policy and exchange rate in inflation targeting emerging countries: the case of three East Asian countries," MPRA Paper 12034, University Library of Munich, Germany, revised 09 Dec 2008. [Downloadable!]
  10. Robert Tchaidze & Alina Carare, 2004. "The Use and Abuse of Taylor Rules: How precisely can we estimate them?," Econometric Society 2004 Latin American Meetings 132, Econometric Society. [Downloadable!]
    Other versions:
  11. Thomas Lubik & Frank Schorfheide, 2003. "Do Central Banks Respond to Exchange Rate Movements? A Structural Investigation," Economics Working Paper Archive 505, The Johns Hopkins University,Department of Economics. [Downloadable!]
    Other versions:
  12. Adolfson, Malin, 2002. "Incomplete Exchange Rate Pass-Through and Simple Monetary Policy Rules," Working Paper Series 136, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
    Other versions:
  13. Helmut Wagner, 2001. "Implications of Globalization for Monetary Policy," IMF Working Papers 01/184, International Monetary Fund. [Downloadable!]
  14. Cleomar Gomes da Silva & Luiz Carlos Bresser-Pereira, 2008. "Inflation Targeting in Brazil: a Keynesian Approach," Textos para discussão 158, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil). [Downloadable!]
  15. Guy Debelle & Jenny Wilkinson, 2002. "Inflation Targeting and the Inflation Process: Some Lessons from an Open Economy," RBA Research Discussion Papers rdp2002-01, Reserve Bank of Australia. [Downloadable!]
  16. Ilan GOLDFAJN & Gino OLIVARES, 2001. "Can Flexible Exchange Rates Still “Work” In Financially Open Economies?," G-24 Discussion Papers 8, United Nations Conference on Trade and Development. [Downloadable!]
  17. Marcelo Ochoa & Patricio Valenzuela, 2004. "Impactos de un Shock Externo en un Modelo Estocástico de Equilibrio General para una Economía Abierta: El Caso de Chile," Macroeconomics 0407007, EconWPA. [Downloadable!]
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