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Incomplete Exchange Rate Pass-Through and Simple Monetary Policy Rules

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  • Adolfson, Malin

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

Abstract

The performance of various monetary rules is investigated in an open economy with incomplete exchange rate pass-through. Implementing monetary policy through an exchange-rate augmented policy rule does not improve social welfare compared to using an optimized Taylor rule, irrespective of the degree of pass-through. However, an indirect exchange rate response, through a policy reaction to Consumer Price Index (CPI) inflation rather than to domestic inflation, is welfare enhancing in all pass-through cases. This result is moreover independent of whether society values domestic or CPI inflation stabilization. The only case where a direct real exchange rate response is slightly welfare improving occurs when the other reaction coefficients, on inflation and output, are sub-optimal.

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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 478.

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Length: 30 pages
Date of creation: 31 Oct 2001
Date of revision:
Handle: RePEc:hhs:hastef:0478

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Keywords: Exchange rate pass-through; monetary policy; simple policy rules; small open economy; Taylor rule;

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References

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Citations

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Cited by:
  1. Bask, Mikael, 2011. "A Case for Interest Rate Inertia in Monetary Policy," Working Paper Series 2011:16, Uppsala University, Department of Economics.
  2. Martins Bitans, 2004. "Pass-Through of Exchange Rates to Domestic Prices in East European Countries and the Role of Economic Enviroment," Working Papers 2004/04, Latvijas Banka.
  3. 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.
  4. Ozge Senay, 2007. " Interest Rate Rules and Welfare in Open Economies," CDMA Working Paper Series 0715, Centre for Dynamic Macroeconomic Analysis.
  5. Deming Luo & Stephen Ferris, 2008. "Optimal Simple Monetary Policy Rules in a Small Open Economy with Exchange Rate Imperfections," Carleton Economic Papers 08-03, Carleton University, Department of Economics.
  6. Winkelried, Diego, 2012. "Traspaso del tipo de cambio y metas de inflación en el Perú," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 23, pages 9-24.
  7. Argov, Eyal & Elkayam, David, 2007. "An Estimated New Keynesian Model for Israel," MPRA Paper 9412, University Library of Munich, Germany.
  8. Winkelried, Diego, 2011. "Exchange rate pass-through and inflation targeting in Peru," Working Papers 2011-012, Banco Central de Reserva del Perú.
  9. Pavasuthipaisit, Robert, 2010. "Should inflation-targeting central banks respond to exchange rate movements?," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 460-485, April.
  10. Fernando Alexandre & Pedro Bação & John Driffill, 2007. "Optimal monetary policy with a regime-switching exchange rate in a forward-looking model," GEMF Working Papers 2007-09, GEMF - Faculdade de Economia, Universidade de Coimbra.
  11. Gerberding, Christina & Worms, Andreas & Seitz, Franz, 2004. "How the Bundesbank really conducted monetary policy: An analysis based on real-time data," Discussion Paper Series 1: Economic Studies 2004,25, Deutsche Bundesbank, Research Centre.
  12. Mukherjee, Sanchita, 2011. "The effects of capital market openness on exchange rate pass-through and welfare in an inflation targeting small open economy," MPRA Paper 30478, University Library of Munich, Germany.
  13. Siok Kun, Sek, 2009. "The impacts of economic structures on the performance of simple policy rules in a small open economy," MPRA Paper 25065, University Library of Munich, Germany.
  14. Cavoli, Tony, 2009. "Is fear of floating justified?: The East Asia experience," Journal of Policy Modeling, Elsevier, vol. 31(1), pages 1-16.
  15. Nils Jannsen & Melanie Klein, 2011. "The International Transmission of Euro Area Monetary Policy Shocks," Kiel Working Papers 1718, Kiel Institute for the World Economy.
  16. Argov, Eyal & Binyamini, Alon & Elkayam, David & Rozenshtrom, Irit, 2007. "A Small Macroeconomic Model to Support Inflation Targeting in Israel," MPRA Paper 4784, University Library of Munich, Germany.
  17. William D. Craighead, 2012. "Monetary Rules and Sectoral Unemployment in Open Economies," Wesleyan Economics Working Papers 2012-001, Wesleyan University, Department of Economics.

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