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Time Inconsistency and the Exchange Rate Channel of Monetary Policy

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  • Leitemo, Kai
  • Roisland, Oistein
  • Torvik, Ragnar

Abstract

This paper analyses time-inconsistency problems related to the exchange rate channel of monetary policy. Within a simple open-economy macroeconomic model, where the exchange rate is the only forward-looking variable, we show that a difference emerges between optimal policy under discretion and under commitment. Moreover, the nature of the time-inconsistency problem resembles that resulting from standard New Keynesian models: when cost-push shocks occur, the exchange rate channel gives rise to excessive output stabilisation and insufficient inertia in monetary policy under a discretionary policy. Copyright 2002 by The editors of the Scandinavian Journal of Economics.

Suggested Citation

  • Leitemo, Kai & Roisland, Oistein & Torvik, Ragnar, 2002. " Time Inconsistency and the Exchange Rate Channel of Monetary Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(3), pages 391-397, September.
  • Handle: RePEc:bla:scandj:v:104:y:2002:i:3:p:391-97
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    Cited by:

    1. Bas van Aarle, 2013. "Structural reforms and fiscal adjustments: policy options for the euro area," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 16(4), pages 320-335, December.
    2. Wollmershauser, Timo, 2006. "Should central banks react to exchange rate movements? An analysis of the robustness of simple policy rules under exchange rate uncertainty," Journal of Macroeconomics, Elsevier, vol. 28(3), pages 493-519, September.
    3. Bas Aarle & Harry Garretsen & Cindy Moons, 2008. "Accession to the euro-area: a stylized analysis using a NK model," International Economics and Economic Policy, Springer, vol. 5(1), pages 5-24, July.
    4. Alfred Guender, 2005. "On discretion versus commitment and the role of the direct exchange rate channel in a forward-looking open economy model," International Economic Journal, Taylor & Francis Journals, vol. 19(3), pages 355-377.
    5. Lin, Yo-Long, 2017. "Is the price path learnable under a fixed exchange rate regime?," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 355-366.
    6. Moons, Cindy & Garretsen, Harry & van Aarle, Bas & Fornero, Jorge, 2007. "Monetary policy in the New-Keynesian model: An application to the Euro Area," Journal of Policy Modeling, Elsevier, vol. 29(6), pages 879-902.
    7. Kai Leitemo & Øistein Røisland & Ragnar Torvik, 2005. "Monetary policy rules and the exchange rate channel," Applied Financial Economics, Taylor & Francis Journals, vol. 15(16), pages 1165-1170.
    8. Mustafa Caglayan & Zainab Jehan & Kostas Mouratidis, 2016. "Asymmetric Monetary Policy Rules for an Open Economy: Evidence from Canada and the Uk," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 21(3), pages 279-293, July.
    9. VAN AARLE, Bas & GARRETSEN, Harry & MOONS, Cindy, 2007. "Accession to the Euro-area: A stylized analysis using a NK model," Working Papers 2007015, University of Antwerp, Faculty of Applied Economics.
    10. Caglayan, Mustafa & Jehan, Zainab & Mouratidis, Kostas, 2012. "Asymmetric monetary policy rules for open economies: Evidence from four countries," MPRA Paper 37401, University Library of Munich, Germany.
    11. Jean-Paul Lam, 2003. "Alternative Targeting Regimes, Transmission lags and the Exchange rate Channel," Macroeconomics 0309005, EconWPA, revised 03 Dec 2003.
    12. Bas van Aarle & Harry Garretsen & Florence Huart, 2003. "Transatlantic Monetary and Fiscal Policy Interaction," CESifo Working Paper Series 1042, CESifo Group Munich.
    13. Jose A. Lopez & Mark M. Spiegel, 2002. "Financial structure and macroeconomic performance over the short and long run," Pacific Basin Working Paper Series 2002-05, Federal Reserve Bank of San Francisco.

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