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Optimal real exchange rate targeting: a stochastic analysis

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Francesco Menoncin
Marco Tronzano

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Abstract

This paper extends the literature on real exchange rate targeting inside a stochastic optimization framework where the real exchange rate displays long run mean reversion while temporarily reflecting a “liquidity effect”. When real exchange rate volatility is constant, an active stabilization rule is welfare increasing with respect to non intervention only beyond a given volatility threshold. Moreover, the welfare gains are larger the lower is the degree of mean reversion. Under a stochastic volatility assumption, the policy maker’s intertemporal discount rate has instead a major influence, and real exchange rate targeting is welfare increasing only if the policymaker is sufficiently farsighted.

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Paper provided by University of Brescia, Department of Economics in its series Working Papers with number ubs0401.

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  1. Uribe, Martin, 2003. "Real exchange rate targeting and macroeconomic instability," Journal of International Economics, Elsevier, vol. 59(1), pages 137-159, January. [Downloadable!] (restricted)
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  2. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  3. Frederic S. Mishkin, 2000. "Inflation Targeting in Emerging-Market Countries," American Economic Review, American Economic Association, vol. 90(2), pages 105-109, May. [Downloadable!] (restricted)
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  4. Dornbusch, Rudiger, 1982. "PPP Exchange-Rate Rules and Macroeconomic Stability," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 158-65, February. [Downloadable!] (restricted)
  5. Paul R. Masson, 1997. "The Scope for Inflation Targeting in Developing Countries," IMF Working Papers 97/130, International Monetary Fund.
  6. Khalid Sekkat & Aristomène Varoudakis, 1998. "Exchange-Rate Management and Manufactured Exports in Sub-Saharan Africa," OECD Development Centre Working Papers 134, OECD, Development Centre. [Downloadable!]
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  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
  8. Bates, David S, 1996. "Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 69-107. [Downloadable!] (restricted)
  9. Michael B. Devereux, 1997. "Real Exchange Rates and Macroeconomics: Evidence and Theory," Canadian Journal of Economics, Canadian Economics Association, vol. 30(4), pages 773-808, November.
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  11. Caporale, Tony & Doroodian, Khosrow, 1994. "Exchange rate variability and the flow of international trade," Economics Letters, Elsevier, vol. 46(1), pages 49-54, September. [Downloadable!] (restricted)
  12. Peter Montiel & Jonathan David Ostry, 1991. "Macroeconomic Implications of Real Exchange Rate Targeting in Developing Countries," IMF Working Papers 91/29, International Monetary Fund.
  13. Surico, Paolo, 2003. "US Monetary Policy Rules: the Case for Asymmetric Preferences," Royal Economic Society Annual Conference 2003 199, Royal Economic Society. [Downloadable!]
  14. Sukar, Abdul-Hamid & Hassan, Seid, 2001. "US exports and time-varying volatility of real exchange rate," Global Finance Journal, Elsevier, vol. 12(1), pages 109-119. [Downloadable!] (restricted)
  15. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  16. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June. [Downloadable!] (restricted)
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  17. Gil-Alana, Luis A., 2000. "Mean reversion in the real exchange rates," Economics Letters, Elsevier, vol. 69(3), pages 285-288, December. [Downloadable!] (restricted)
  18. MacDonald, Ronald, 1999. "Exchange Rate Behaviour: Are Fundamentals Important?," Economic Journal, Royal Economic Society, vol. 109(459), pages F673-91, November. [Downloadable!] (restricted)
  19. Sarno, Lucio & Taylor, Mark P., 1998. "Real exchange rates under the recent float: unequivocal evidence of mean reversion," Economics Letters, Elsevier, vol. 60(2), pages 131-137, August. [Downloadable!] (restricted)
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  20. Christopher F. Baum & Mustafa Caglayan & John Barkoulas, 1998. "Nonlinear Adjustment to Purchasing Power Parity in the post-Bretton Woods Era," Boston College Working Papers in Economics 404., Boston College Department of Economics, revised 16 Nov 1999. [Downloadable!]
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  21. Rudiger Dornbusch, 1980. "Exchange Rate Rules and Macroeconomic Stability," NBER Working Papers 0473, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  22. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier. [Downloadable!] (restricted)
  23. Singh, Tarlok, 2002. "On the GARCH Estimates of Exchange Rate Volatility in India," Applied Economics Letters, Taylor and Francis Journals, vol. 9(6), pages 391-95, May. [Downloadable!] (restricted)
  24. Peel, David & Sarno, Lucio & Taylor, Mark P, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles," CEPR Discussion Papers 2658, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  25. Arize, Augustine C & Osang, Thomas & Slottje, Daniel J, 2000. "Exchange-Rate Volatility and Foreign Trade: Evidence from Thirteen LDC's," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(1), pages 10-17, January.
  26. Ronald J. Mahieu & Peter C. Schotman, 1998. "An empirical application of stochastic volatility models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 13(4), pages 333-360. [Downloadable!]
  27. José Saúl Lizondo, 1993. "Real Exchange Rate Targeting Under Imperfect Asset Substitutability," IMF Working Papers 93/38, International Monetary Fund.
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  1. Roberto Casarin & Carmine Trecroci, 2006. "Business Cycle and Stock Market Volatility: A Particle Filter Approach," Working Papers ubs0603, University of Brescia, Department of Economics. [Downloadable!]
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