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Monetary-Exchange Rate Policy and Current Account Dynamics

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  • Malik, Hamza

Abstract

A dynamic stochastic general equilibrium monetary model with incomplete and imperfect asset markets, monopolistic competition and staggered nominal price rigidities is developed to shed light on the role of exchange rate and its relation with current account dynamics in the formulation of monetary-exchange rate policies. The paper shows that because of incomplete risk sharing, due to incomplete asset markets, the dynamic relationship between real exchange rate and net foreign assets affect the behaviour of domestic inflation and aggregate output. This, in turn, implies that the optimal monetary policy entail a response to net foreign asset position or the real exchange rate gap defined as the difference between actual real exchange rate and the value that would prevail with flexible prices and complete asset markets. In comparing the performance of alternative monetary-exchange rate policy rules, an interesting and fairly robust result that stands out is that ‘dirty floating’ out-performs flexible exchange rate regime with domestic inflation targeting.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 455.

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Date of creation: Aug 2005
Date of revision: Sep 2006
Handle: RePEc:pra:mprapa:455

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Keywords: optimal monetary policy; incomplete asset markets; net foreign assets; current account dynamics; inflation targeting; exchange rate policy;

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Cited by:
  1. Plasmans, J.E.J. & Fornero, J. & Michalak, T., 2007. "A Microfounded Sectoral Model for Open Economies," Discussion Paper, Tilburg University, Center for Economic Research 2007-39, Tilburg University, Center for Economic Research.

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