Central Bank Learning, Terms Of Trade Shocks & Currency Risks: Should Only Inflation Matter For Monetary Policy?
AbstractThis paper examines the role of interest rate policy in a small open economy subject to terms of trade shocks, and time-varying currency risks. The private sector makes optimal decisions in an intertemporal non-linear setting with rational, forward-looking expectations. In contrast, the monetary authority practices "least-squares learning" about the evolution of inflation, output growth, and exchange rate depreciation in alternative policy scenarios. Interest rates are set by linear quadratic optimization, with the objectives for inflation, output growth, or depreciation depending on current conditions. The simulation results show that the prefered stance is one which targets inflation only. Including other targets such as growth and exchange rate changes significantly increases output variability, and unambiguously decreases welfare.
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Bibliographic InfoPaper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 831.
Length: 28 pages
Date of creation: 2002
Date of revision:
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Postal: Department of Economics, The University of Melbourne, 5th Floor, Economics and Commerce Building, Victoria, 3010, Australia
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More information through EDIRC
Currency risks; learning; parameterized expectations; policy targets;
Other versions of this item:
- G.C. Lim & P.D. McNelis, 2002. "Central Bank Learning, Terms of Trade Shocks & Currency Risks: Should Only Inflation Matter for Monetary Policy?," Computing in Economics and Finance 2002 68, Society for Computational Economics.
- 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
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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