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Global Commodity Prices, Monetary Transmission, and Exchange Rate Pass-Through in the Pacific Islands

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  • Shanaka J. Peiris
  • Ding Ding
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    Abstract

    Pacific Islands countries are vulnerable to commodity price shocks, and this poses challenges to monetary policy. The high degree of exchange rate pass-through to headline inflation and the weak monetary transmission mechanism in PICs suggest a greater efficacy of exchange rate changes in affecting inflation rather than monetary policy. To assess the tradeoff between the use of the exchange rate and monetary policy in macroeconomic stabilization, we employ a model-based approach to examine the optimal policy in response to the historical distribution of exogenous shocks in a Pacific Island (Tonga). The empirical evidence and model simulations tilt in the favor of exchange rate policy given the close relationship between exchange rate changes and headline inflation and the low interest rate sensitivity of aggregate demand.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/176.

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    Length: 16
    Date of creation: 01 Jul 2012
    Date of revision:
    Handle: RePEc:imf:imfwpa:12/176

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    Keywords: Commodity prices; Economic models; Exchange rates; External shocks; Monetary transmission mechanism; Pacific Island Countries; exchange rate; inflation; monetary policy; exchange rate targeting; monetary transmission; monetary fund; exchange rate changes; real exchange rate; aggregate demand; exchange rate pass; exchange rate flexibility; nominal exchange rate; monetary aggregates; monetary authority; monetary authority of singapore; exchange rate regimes; monetary economics; monetary policy transmission mechanisms; exchange rate policy; monetary shocks; exchange rate peg; monetary indicator; monetary indicators; basket of currencies; central bank; nominal effective exchange rate; effective exchange rate; interest rate targeting; inflation-targeting; effective exchange rates; monetary aggregate; monetary management; exchange rate channels; monetary policy regime; exchange rate regime; exchange rate fluctuations; exchange rate adjustment; bilateral exchange rate; intermediate exchange rate; exchange rate systems; exchange rate policies; transmission of monetary policy; exchange rate index; exchange rate peg regime; currency risk;

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    1. Kim, Soyoung & Roubini, Nouriel, 2000. "Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 561-586, June.
    2. Eric Parrado, 2004. "Singapore's Unique Monetary Policy," IMF Working Papers 04/10, International Monetary Fund.
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