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The Choice of Monetary Policy Regime for Small Open Economies

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  • Kai Leitemo
  • Oistein Roisland

Abstract

Inflation targeting and exchange rate targeting, including monetary union, are analyzed in a simple, estimated macroeconomic model of a small open economy. Flexible inflation targeting produces lower nominal and real variability than exchange rate targeting because the latter gives rise to persistent oscillations in the real interest rate and the real exchange rate due to the 'Walters' effect'. We find, however, that with commitment to simple instrument rules, the performance of flexible inflation targeting can almost be matched.

Suggested Citation

  • Kai Leitemo & Oistein Roisland, 2002. "The Choice of Monetary Policy Regime for Small Open Economies," Annals of Economics and Statistics, GENES, issue 67-68, pages 463-494.
  • Handle: RePEc:adr:anecst:y:2002:i:67-68:p:463-494
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    File URL: http://www.jstor.org/stable/20076356
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    1. Laurence Ball, 2002. "Policy Rules and External Shocks," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 3, pages 047-064 Central Bank of Chile.
    2. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
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    4. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    5. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters,in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
    6. Nargis Bharucha & Christopher Kent, 1998. "Inflation Targeting in a Small Open Economy," RBA Research Discussion Papers rdp9807, Reserve Bank of Australia.
    7. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters,in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
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    14. Leitemo, Kai & Soderstrom, Ulf, 2005. "Simple monetary policy rules and exchange rate uncertainty," Journal of International Money and Finance, Elsevier, vol. 24(3), pages 481-507, April.
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    Cited by:

    1. Kai Leitemo & Øistein Røisland & Ragnar Torvik, 2006. "Should Inflation-Targeting Central Banks Care about Traded and Non-Traded Sectors?," The IUP Journal of Bank Management, IUP Publications, vol. 0(1), pages 53-63, February.

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