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The Complex Response of Monetary Policy to the Exchange Rate

Author

Listed:
  • Ram Sharan Kharel

    (Brunel University, UK)

  • Christopher Martin

    (Brunel University, UK)

  • Costas Milas

    (Keele University, UK and The Rimini Centre for Economics Analysis, Italy)

Abstract

We estimate a flexible non-linear monetary policy rule for the UK to examine the response of policymakers to the real exchange rate. We have three main findings. First, policymakers respond to real exchange rate misalignment rather than to the real exchange rate itself. Second, policymakers ignore small deviations of the exchange rate; they only respond to real exchange under-valuations of more than 4% and over-valuations of more than 5%. Third, the response of policymakers to inflation is smaller when the exchange rate is over-valued and larger when it is under-valued. None of these responses is allowed for in the widely-used Taylor rule, suggesting that monetary policy is better analysed using a more sophisticated model, such as the one suggested in this paper.

Suggested Citation

  • Ram Sharan Kharel & Christopher Martin & Costas Milas, 2007. "The Complex Response of Monetary Policy to the Exchange Rate," Working Paper series 37_07, Rimini Centre for Economic Analysis.
  • Handle: RePEc:rim:rimwps:37_07
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    Cited by:

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    2. Anh Dinh Minh Nguyen, 2017. "U.K. Monetary Policy under Inflation Targeting," Bank of Lithuania Working Paper Series 41, Bank of Lithuania.
    3. Hoda Selim, 2012. "Exploring the Role of the Exchange Rate in Monetary Policy in Egypt," Working Papers 733, Economic Research Forum, revised 2012.
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    5. Khvostova, I. & Novak, A., 2014. "Monetary Stabilization: Modeling and Estimation for Russian Economy in 2004-2012," Journal of the New Economic Association, New Economic Association, vol. 23(3), pages 89-105.

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    More about this item

    Keywords

    monetary policy; asset prices; nonlinearity;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • 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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