Fixed Exchange Rate Versus Inflation Targeting: Evidence from DSGE Modelling
AbstractWe evaluate implications of inflation targeting versus fixed exchange rate regime for the UK, Sweden, Poland, the Czech Republic, Estonia, Latvia and Lithuania, i.e. seven EU non-euro area countries. To this end, we estimate a small open economy DSGE model and simulate a model under estimated structural parameters and different sets of policy parameters. The results obtained are compared in terms of inflation, output gap and interest rate volatility. For inflation targeting countries, a policy switch to fixed exchange rate would entail 3–6 times higher inflation volatility. In the Baltic economies, a policy change to inflation targeting with fully flexible exchange rate would amplify inflation volatility 2–4 times, whereas the existing price stabilisation and exchange rate fluctuations within the ERM II bands would entail 3–6 times more volatile inflation. Policy simulations thus show evidence that in all the countries the existing monetary rule guarantees more stable inflation and output than under alternative regimes.
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Bibliographic InfoPaper provided by Latvijas Banka in its series Working Papers with number 2011/02.
Date of creation: 25 Jul 2011
Date of revision:
DSGE; small open economy; fixed exchange rate; inflation targeting; Bayesian estimation;
Find related papers by JEL classification:
- C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
- C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- 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-2011-08-29 (All new papers)
- NEP-CBA-2011-08-29 (Central Banking)
- NEP-DGE-2011-08-29 (Dynamic General Equilibrium)
- NEP-EEC-2011-08-29 (European Economics)
- NEP-MAC-2011-08-29 (Macroeconomics)
- NEP-MON-2011-08-29 (Monetary Economics)
- NEP-OPM-2011-08-29 (Open Economy Macroeconomics)
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