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Estimating Central Bank preferences in a small open economy: Sweden 1995-2009

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  • D'Adamo, Gaetano

Abstract

Interest Rate rules are often estimated as simple reaction functions linking the policy interest rate to variables such as (forecasted) inflation and the output gap; however, the coefficients estimated with this approach are convolutions of structural and preference parameters. I propose an approach to estimate Central Bank preferences starting from the Central Bank's optimization problem within a small open economy. When we consider open economies in a regime of Inflation Targeting, the issue of the role of the exchange rate in the Monetary Policy rule becomes relevant. The empirical analysis is conducted on Sweden, to verify whether the recent stabilization of the Krona/Euro exchange rate was due to “Fear of Floating”; the results show that the exchange rate might not have played a role in monetary policy, suggesting that the stabilization probably occurred as a result of increased economic integration and business cycle convergence.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 26575.

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Date of creation: 09 Nov 2010
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Handle: RePEc:pra:mprapa:26575

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Keywords: Interest Rate Rules; Inflation Targeting; Central Bank Preferences; Fear of Floating.;

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  1. Dick van Dijk & Haris Munandar & Christian M. Hafner, 2005. "The Euro Introduction and Non-Euro Currencies," Tinbergen Institute Discussion Papers, Tinbergen Institute 05-044/4, Tinbergen Institute, revised 08 Jun 2006.
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  3. Sean Collins & Pierre L. Siklos, 2004. "Optimal Monetary Policy Rules and Inflation Targets: Are Australia, Canada, and New Zealand Different from the U.S.?," Open Economies Review, Springer, Springer, vol. 15(4), pages 347-362, October.
  4. J. James Reade & Ulrich Volz, 2009. "Too Much to Lose, or More to Gain? Should Sweden Join the Euro?," Economics Series Working Papers, University of Oxford, Department of Economics 442, University of Oxford, Department of Economics.
  5. Carlo Favero & Francesco Giavazzi, 2008. "Should the Euro Area be Run as a Closed Economy?," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 331, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  6. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  7. Ball, Christopher P. & Reyes, Javier, 2008. "Inflation targeting or fear of floating in disguise? A broader perspective," Journal of Macroeconomics, Elsevier, Elsevier, vol. 30(1), pages 308-326, March.
  8. Frankel, Jeffrey A & Rose, Andrew K, 1998. "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 108(449), pages 1009-25, July.
  9. Eliasson, Ann-Charlotte, 2001. "Is the Short-run Phillips Curve Nonlinear? Empirical Evidence for Australia, Sweden and the United States," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 124, Sveriges Riksbank (Central Bank of Sweden).
  10. Tor Jacobson & Per Jansson & Anders Vredin & Anders Warne, 2001. "Monetary policy analysis and inflation targeting in a small open economy: a VAR approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 16(4), pages 487-520.
  11. Juselius, Katarina, 2006. "The Cointegrated VAR Model: Methodology and Applications," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780199285679, October.
  12. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  13. Marcela Meirelles Aurelio, 2005. "Do we really know how inflation targeters set interest rates?," Research Working Paper, Federal Reserve Bank of Kansas City RWP 05-02, Federal Reserve Bank of Kansas City.
  14. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, Elsevier, vol. 49(6), pages 1603-1635, August.
  15. M. Camarero & J. Ordonez & C. R. Tamarit, 2002. "Monetary transmission in Spain: a structural cointegrated VAR approach," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 34(17), pages 2201-2212.
  16. Eduardo Levy-Yeyati & Federico Sturzenegger, 2003. "To Float or to Fix: Evidence on the Impact of Exchange Rate Regimes on Growth," American Economic Review, American Economic Association, American Economic Association, vol. 93(4), pages 1173-1193, September.
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