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Exchange Rates, Inflation and Monetary Policy Objectives in Open Economies: The Experience of Chile

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Rodrigo Caputo

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Abstract

This paper characterizes, empirically, the conduct of monetary policy in a small open economy. In particular, using as a case study the Chilean inflation targeting experience, we assess the role of the exchange rate in the determination of the interest rate. We conclude that Chile has adopted what Svensson (1997) calls a gradual approach to targeting inflation. This means, in practice, that the central bank modifies its policy instrument, the interest rate, whenever expected inflation or output deviate from its target. In this context, we find evidence that the monetary authorities also react to real exchange rate misalignments. This reaction is comparatively larger than that found in developed economies. Finally, the evidence, although not conclusive, seems to suggest a non linear response to exchange rate misalignments: the central bank reacts strongly to large deviations rather than to small ones

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Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 298.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:298

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Keywords: Monetary Policy Open Economy GMM Estimation of Policy Reaction Function

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Find related papers by JEL classification:
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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Cited by:
(explanations, 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. Rodrigo Caputo, 2004. "Habit formation and its implications for small open economies," Money Macro and Finance (MMF) Research Group Conference 2003 11, Money Macro and Finance Research Group. [Downloadable!]
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