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Inflation Targeting and Exchange Rate Co-ordination

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  • Fernando Alexandre

    ()
    (Universidade do Minho - NIPE and Birkbeck College)

  • John Drifill

    ()
    (Birkbeck College)

  • Fabio Spagniolo

    ()
    (Birkbeck College)

Abstract

In a linear rational expectations two-country model, using an aggregate demand-aggregate supply framework, we analyze the effects of the adoption of an inflation targeting regime on exchange rate volatility and the possible scope for policy coordination. This analysis is conducted using optimized interest rate policy rules within a calibrated model. Rules for interest rates that respond either to exchange rates or to portfolio shocks give improved performance and permit gains from international coordination. Optimized Taylor Rules perform relatively well.

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Bibliographic Info

Paper provided by NIPE - Universidade do Minho in its series NIPE Working Papers with number 9/2001.

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Date of creation: 2001
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Handle: RePEc:nip:nipewp:9/2001

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Related research

Keywords: Inflation Targeting; Taylor Rule; Exchange Rate Coordination; Rational Expectations.;

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References

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  1. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  2. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  3. Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies.
  4. Bennett T. McCallum, 1997. "The alleged instability of nominal income targeting," Reserve Bank of New Zealand Discussion Paper Series G97/6, Reserve Bank of New Zealand.
  5. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
  6. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  7. Fair, Ray C, 1993. "Testing the Rational Expectations Hypothesis in Macroeconometric Models," Oxford Economic Papers, Oxford University Press, vol. 45(2), pages 169-90, April.
  8. Glenn Rudebusch, 2000. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Econometric Society World Congress 2000 Contributed Papers 0065, Econometric Society.
  9. Smets, Frank, 1997. "Financial Asset Prices and Monetary Policy: Theory and Evidence," CEPR Discussion Papers 1751, C.E.P.R. Discussion Papers.
  10. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S61-82, Suppl. De.
  11. Chris Ryan & Christopher Thompson, 2000. "Inflation Targeting and Exchange Rate Fluctuations in Australia," RBA Research Discussion Papers rdp2000-06, Reserve Bank of Australia.
  12. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  13. Taylor, John B., 1981. "On the relation between the variability of inflation and the average inflation rate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 57-85, January.
  14. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  15. Charles Engel & Craig S. Hakkio, 1994. "The distribution of exchange rates in the EMS," Research Working Paper 94-03, Federal Reserve Bank of Kansas City.
  16. Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
  17. Arturo Extrella & Jeffrey C. Fuhrer, 1998. "Dynamic inconsistencies: counterfactual implications of a class of rational expectations models," Working Papers 98-5, Federal Reserve Bank of Boston.
  18. Sutherland, Alan, 2001. "Inflation Targeting in a Small Open Economy," CEPR Discussion Papers 2726, C.E.P.R. Discussion Papers.
  19. Martin Evans & Paul Wachtel, 1993. "Inflation regimes and the sources of inflation uncertainty," Proceedings, Federal Reserve Bank of Cleveland, pages 475-520.
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Cited by:
  1. Fernando Alexandre & Pedro Bação, 2002. "Equitity prices and Monetary Policy: An Overview with an Exploratory Model," NIPE Working Papers 1/2002, NIPE - Universidade do Minho.

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