Is more exchange rate intervention necessary in small open economies? The role of risk premium and commodity shocks
AbstractWe estimate how the monetary policy works in small open economies with inflation target. To do so, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of representative small open economies (including Australia, Chile, Colombia, Peru and New Zealand) presents strong differences due to shocks from the international financial markets (risk premium shocks, mainly) that explain mostly the variability of the real exchange rate, which has important reallocation effects in the short run. By using the allocations of the Ramsey problem as benchmark, this article shows that if the central banks in small open economies want to reduce the observed volatility of the inflation rate and the output gap, more exchange rate intervention is necessary in order to reduce the volatility produced by risk premium shocks.
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Bibliographic InfoPaper provided by Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines in its series ILADES-Georgetown University Working Papers with number inv248.
Length: 25 pages
Date of creation: Apr 2010
Date of revision:
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-24 (All new papers)
- NEP-CBA-2010-07-24 (Central Banking)
- NEP-DGE-2010-07-24 (Dynamic General Equilibrium)
- NEP-MAC-2010-07-24 (Macroeconomics)
- NEP-MON-2010-07-24 (Monetary Economics)
- NEP-OPM-2010-07-24 (Open Economy Macroeconomics)
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