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Should monetary policy attempt to reduce exchange rate volatility in New Zealand?

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Author Info
Dominick Stephens (Reserve Bank of New Zealand)
Abstract

Previous research has suggested that including exchange rate stabilisation within the goals of monetary policy significantly increases the volatility of inflation, output and interest rates, and that the benefits of exchange rate stabilisation therefore do not justify the costs. The current paper tests whether this finding is robust when various alternative models of exchange rate determination are considered. The analysis is carried out in the context of optimal full-information monetary policy rules in a New Keynesian model that is calibrated to represent the New Zealand economy. For the models that feature rational expectations, we support the conclusion that seeking to avoid exchange rate volatility would have more costs than benefits. Indeed, a major cost of including the exchange rate within the goals of monetary policy is that inflation expectations become less anchored to the inflation target, meaning that larger movements in nominal interest rates are required to control inflation.

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File URL: http://www.rbnz.govt.nz/research/discusspapers/dp06_05.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2006/05.

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Length: 28 p.
Date of creation: May 2006
Date of revision:
Handle: RePEc:nzb:nzbdps:2006/05

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Find related papers by JEL classification:
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

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Sam Warburton & Kirdan Lees, 2005. "A happy "halfway-house"? Medium term inflation targeting in New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2005/03, Reserve Bank of New Zealand. [Downloadable!]
  2. Kirdan Lees, 2003. "The stabilisation problem: the case of New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2003/08, Reserve Bank of New Zealand. [Downloadable!]
  3. Leitemo, Kai & Söderström, Ulf, 2001. "Simple Monetary Policy Rules and Exchange Rate Uncertainty," Working Paper Series 122, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
    Other versions:
  4. Sharon McCaw & Satish Ranchhod, 2002. "The Reserve Bank's forecasting performance," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 65, December. [Downloadable!]
  5. Dominick Stephens, 2004. "The equilibrium exchange rate according to PPP and UIP," Reserve Bank of New Zealand Discussion Paper Series DP 2004/03, Reserve Bank of New Zealand. [Downloadable!]
  6. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies. [Downloadable!]
    Other versions:
  7. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?," NBER Working Papers 8934, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. James Twaddle & David Hargreaves & Tim Hampton, 2006. "Other stabilisation objectives within an inflation targeting regime: Some stochastic simulation experiments," Reserve Bank of New Zealand Discussion Paper Series DP2006/04, Reserve Bank of New Zealand. [Downloadable!]
  9. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Blackwell Publishing, vol. 72(3), pages 707-734, 07. [Downloadable!] (restricted)
    Other versions:
  10. Anella Munro, 2005. "UIP, Expectations and the Kiwi," Reserve Bank of New Zealand Discussion Paper Series DP2005/05, Reserve Bank of New Zealand. [Downloadable!]
  11. Kenneth Rogoff & Yu-chin Chen, 2002. "Commodity Currencies and Empirical Exchange Rate Puzzles," IMF Working Papers 02/27, International Monetary Fund.
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. James Twaddle & David Hargreaves & Tim Hampton, 2006. "Other stabilisation objectives within an inflation targeting regime: Some stochastic simulation experiments," Reserve Bank of New Zealand Discussion Paper Series DP2006/04, Reserve Bank of New Zealand. [Downloadable!]
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