The Complex Response of Monetary Policy to the Exchange Rate
AbstractWe estimate a flexible non-linear monetary policy rule for the UK to examine the response of policymakers to the real exchange rate. We have three main findings. First, policymakers respond to real exchange rate misalignment rather than to the real exchange rate itself. Second, policymakers ignore small deviations of the exchange rate; they only respond to real exchange under-valuations of more than 4\% and over-valuations of more than 5\%. Third, the response of policymakers to inflation is smaller when the exchange rate is over-valued and larger when it is under-valued. None of these responses is allowed for in the widely-used Taylor rule, suggesting that monetary policy is better analysed using a more sophisticated model, such as the one suggested in this paper.
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Bibliographic InfoPaper provided by Centre for Economic Research, Keele University in its series Keele Economics Research Papers with number KERP 2006/17.
Length: 24 pages
Date of creation: Sep 2006
Date of revision:
Note: We thank Kevin Lee and Roberto Gonzalez for useful comments and suggestions.
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Postal: Centre for Economic Research, Research Institute for Public Policy and Management, Keele University, Staffordshire ST5 5BG - United Kingdom
Other versions of this item:
- Ram Sharan Kharel & Christopher Martin & Costas Milas, 2010. "The Complex Response Of Monetary Policy To The Exchange Rate," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(1), pages 103-117, 02.
- Costas Milas & Christopher Martin & Ram Sharan Kharel, 2007. "The Complex Response of Monetary Policy to the Exchange Rate," Working Paper Series 37-07, The Rimini Centre for Economic Analysis, revised Jul 2007.
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-11-25 (All new papers)
- NEP-CBA-2006-11-25 (Central Banking)
- NEP-MAC-2006-11-25 (Macroeconomics)
- NEP-MON-2006-11-25 (Monetary Economics)
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