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Money Supply Rules and Exchange Rate Dynamics

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  • Juha Tervala

    ()

Abstract

This paper examines the implications of monetary policy rules for exchange rate dynamics. I extend a standard New Open Economy Macroeconomics model with the introduction of a simple money supply rule, whereby central banks change their monetary policy if output diverges from potential output or if inflation diverges from the target inflation. A key result is that, in the case of permanent technology and monetary shocks, the nominal exchange rate does not follow a random walk; instead, the exchange rate undershoots its long-run value. An undershooting of the exchange rate derives from the active monetary policy that both countries conduct.

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Bibliographic Info

Paper provided by Aboa Centre for Economics in its series Discussion Papers with number 62.

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Length: 30
Date of creation: Dec 2010
Date of revision:
Handle: RePEc:tkk:dpaper:dp62

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Keywords: Monetary policy rules; open economy macroeconomics; exchange rate;

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