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Optimal Monetary Policy Delegation under Incomplete Exchange Rate Pass-Through

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  • Adolfson, Malin

    ()
    (Dept. of Economics, Stockholm School of Economics)

Abstract

The central bank’s optimal objective function is analyzed in a small open economy model allowing for incomplete exchange rate pass-through. The results indicate that social welfare can only be marginally improved by including an explicit exchange-rate term in the delegated objective function, irrespective of the degree of pass-through. An implicit response to the exchange rate, through Consumer Price Index (CPI) inflation targeting is, however, beneficial. Welfare can, moreover, be enhanced by appointing a central banker with a greater preference for interest rate smoothing than that of the society, as a result of surpassing some of the stabilization bias arising under a discretionary policy. Consequently, there are welfare gains from monetary policy inertia. The optimal degree of interest rate smoothing is increasing in the degree of pass-through.

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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 477.

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Length: 37 pages
Date of creation: 31 Oct 2001
Date of revision:
Handle: RePEc:hhs:hastef:0477

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Keywords: Exchange rate pass-through; inflation targeting; interest rate inertia; monetary policy; small open economy;

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References

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Citations

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Cited by:
  1. Adolfson, Malin, 2007. "Incomplete exchange rate pass-through and simple monetary policy rules," Journal of International Money and Finance, Elsevier, vol. 26(3), pages 468-494, April.
  2. Guender, Alfred V., 2003. "Optimal discretionary monetary policy in the open economy: Choosing between CPI and domestic inflation as target variables," Research Discussion Papers 12/2003, Bank of Finland.
  3. Iris Claus & Arthur Grimes, 2003. "Asymmetric Information, Financial Intermediation and the Monetary Transmission Mechanism: A Critical Review," Treasury Working Paper Series 03/19, New Zealand Treasury.

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