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Macroeconomic Effects of Looming Policy Shifts: Non-falsified Expectations and Peso Problems

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  • Vilmunen, Jouko

    ()
    (Bank of Finland Research)

Abstract

Using a standard model as a basis, we analyse the rational expectations macroeconomic equilibrium for an open economy with flexible exchange rates, in which expectations are affected by a perceived possibility of discrete shifts in monetary policy. These discrete shifts are modelled as possible jumps in the money supply process, which is otherwise a smooth random walk. Two such jump models are analysed. In equilibrium, the distribution of endogenous variables is (apparently systematically) affected by peso problems (premia), which reflect distributional peculiarities associated with expectations of possible future policy shifts. It turns out that the macroeconomic effects of peso premia accord closely with intuition regarding the effects of poor credibility of a policy regime: the output gap widens; the levels of real interest rates and domestic prices rise; and the domestic currency appreciates in real terms due to anticipated expansionary shifts in the money supply. Moreover, the key macro-aggregates become more volatile. The effects of peso premia on the nominal interest rate and the exchange rate turn out to be ambiguous.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/DP_13_1998.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 13/1998.

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Length: 48 pages
Date of creation: 02 Jul 1998
Date of revision:
Handle: RePEc:hhs:bofrdp:1998_013

Contact details of provider:
Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: poisson process; policy shifts; peso problem; rational expectations;

References

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  1. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
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  8. Balduzzi, Pierluigi & Bertola, Giuseppe & Foresi, Silverio, 1997. "A model of target changes and the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 223-249, July.
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  18. Robert E. Cumby & Maurice Obstfeld, 1984. "International Interest Rate and Price Level Linkages under Flexible Exchange Rates: A Review of Recent Evidence," NBER Chapters, in: Exchange Rate Theory and Practice, pages 121-152 National Bureau of Economic Research, Inc.
  19. Jean-Pierre DANTHINE & John B. DONALDSON, 1996. "Non-Falsified Expectations, General Equilibrium Asset Pricing and the Peso Problem," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9621, Université de Lausanne, Faculté des HEC, DEEP.
  20. Balduzzi, Pierluigi, et al, 1998. "Interest Rate Targeting and the Dynamics of Short-Term Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(1), pages 26-50, February.
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Cited by:
  1. Kortelainen, Mika, 2001. "Actual and perceived monetary policy rules in a dynamic general equilibrium model of the euro area," Research Discussion Papers 3/2001, Bank of Finland.
  2. Jääskelä, Jarkko & Vilmunen, Jouko, 1999. "Anticipated Monetary Policy and the Dynamic Behaviour of the Term Structure of Interest Rates," Research Discussion Papers 12/1999, Bank of Finland.

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