Ashima Goyal () (Indira Gandhi Institute of Development Research)
Abstract
In a simple open EME macromodel, calibrated to the typical institutions and shocks of a densely populated emerging market economy, a monetary stimulus preceding a temporary supply shock can lower interest rates, raise output, appreciate exchange rates, and lower inflation. Simulations generalize the analytic result with regressions validating the parameter values. Under correct incentives, such as provided by a middling exchange rate regime, which imparts limited volatility to the nominal exchange rate around a trend competitive rate, forex traders support the policy. The policy is compatible with political constraints and policy objectives, but analysis of strategic interactions brings out cases where optimal policy will not be chosen. Supporting institutions are required to coordinate monetary, fiscal policy and markets to the optimal equilibrium. The analysis contributes to understanding the key issues for countries such as India and China that need to deepen markets in order to move to more flexible exchange rate regimes.
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Length: 36 pages Date of creation: Jul 2005 Date of revision: Handle: RePEc:ind:igiwpp:2005-002
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Find related papers by JEL classification: F31 - International Economics - - International Finance - - - Foreign Exchange F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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