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Incomplete exchange rate pass-through and simple monetary policy rules

  • Adolfson, Malin

The performance of various monetary rules is investigated in an open economy with incomplete exchange rate pass-through. Implementing monetary policy through an exchange-rate augmented policy rule does not improve social welfare compared to using an optimized Taylor rule, irrespective of the degree of pass-through. However, an indirect exchange rate response, through a policy reaction to Consumer Price Index (CPI) inflation rather than to domestic inflation, is welfare enhancing in all pass-through cases. This result is moreover independent of whether society values domestic or CPI inflation stabilization. The only case where a direct real exchange rate response is slightly welfare improving occurs when the other reaction coefficients, on inflation and output, are sub-optimal.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 26 (2007)
Issue (Month): 3 (April)
Pages: 468-494

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Handle: RePEc:eee:jimfin:v:26:y:2007:i:3:p:468-494
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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