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A Floating versus Managed Exchange Rate Regime in a DSGE Model of India

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  • Nicoletta Batini

    (National Institute of Public Finance and Policy)

  • Vasco Gabriel
  • Paul Levine
  • Joseph Pearlman

Abstract

We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes : domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic inflation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 21992.

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Date of creation: Jan 2010
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Handle: RePEc:eab:macroe:21992

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Keywords: DSGE model; Indian Economy; monetary interest rate rules; floating versus managed exchange rate; financial frictions;

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References

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  1. Michael B. Devereux & Philip R. Lane, 2000. "Exchange Rates and Monetary Policy in Emerging Market Economies," Working Papers, Hong Kong Institute for Monetary Research 072000, Hong Kong Institute for Monetary Research.
  2. Simon Gilchrist & Jean-Olivier Hairault & Hubert Kempf, 2002. "Monetary policy and the financial accelerator in a monetary union," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 750, Board of Governors of the Federal Reserve System (U.S.).
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  6. Nicoletta Batini & Paul Levine & Joseph Pearlman, 2007. "Monetary Rules in Emerging Economies with Financial Market Imperfections," NBER Chapters, National Bureau of Economic Research, Inc, in: International Dimensions of Monetary Policy, pages 251-311 National Bureau of Economic Research, Inc.
  7. Nicoletta Batini & Stephen P. Millard & Richard Harrison, 2000. "Monetary Policy Rules For An Open Economy," Computing in Economics and Finance 2000, Society for Computational Economics 361, Society for Computational Economics.
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  16. Paul Levine & Joseph Pearlman & Nicoletta Batini, 2009. "Monetary and Fiscal Rules in an Emerging Small Open Economy," IMF Working Papers, International Monetary Fund 09/22, International Monetary Fund.
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Citations

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Cited by:
  1. Vasco Gabriel & Paul Levine & Joseph Pearlman & Bo Yang, 2010. "An Estimated DSGE Model of the Indian Economy," School of Economics Discussion Papers, School of Economics, University of Surrey 1210, School of Economics, University of Surrey.
  2. Paul Levine, 2010. "Monetary Policy in an Uncertain World : Probability Models and the Design of Robust Monetary Rules," Macroeconomics Working Papers, East Asian Bureau of Economic Research 21853, East Asian Bureau of Economic Research.
  3. Levine, Paul & Pearlman, Joseph, 2011. "Monetary and Fiscal Policy in a DSGE Model of India," Working Papers, National Institute of Public Finance and Policy 11/96, National Institute of Public Finance and Policy.
  4. Chetan Ghate & Radhika Pandey & Ila Patnaik, 2011. "Has India emerged? Business cycle stylized facts from a transitioning economy," Indian Statistical Institute, Planning Unit, New Delhi Discussion Papers, Indian Statistical Institute, New Delhi, India 11-05, Indian Statistical Institute, New Delhi, India.
  5. Paul Levine, 2012. "Policy focus: Monetary policy in an uncertain world: probability models and the design of robust monetary rules," Indian Growth and Development Review, Emerald Group Publishing, Emerald Group Publishing, vol. 5(1), pages 70-88, April.
  6. Haider, Adnan & Din, Musleh-ud & Ghani, Ejaz, 2012. "Monetary policy, informality and business cycle fluctuations in a developing economy vulnerable to external shocks," MPRA Paper, University Library of Munich, Germany 42484, University Library of Munich, Germany.
  7. Ghate, Chetan & Pandey, Radhika & Patnaik, Ila, 2011. "Has India emerged? Business cycle facts from a transitioning economy," Working Papers, National Institute of Public Finance and Policy 11/88, National Institute of Public Finance and Policy.

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