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"Leaning with the wind"? An open-economy example

  • Guender, Alfred V.

This paper uses a forward-looking open-economy optimizing model to show that the existence of a real exchange rate channel in the Phillips Curve dramatically alters the conduct of optimal monetary policy. The central bank's optimal reaction function can produce a "lean with the wind" response to domestic IS disturbances and the foreign output gap provided that both a pronounced exchange rate channel exists and the disturbances are highly persistent. The more potent the real exchange rate channel in the Phillips Curve becomes, the greater (smaller) the fluctuations in the output gap (real exchange rate). How this channel affects the variability of the nominal variables depends on the degree of persistence of the disturbances.

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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 30 (2008)
Issue (Month): 3 (September)
Pages: 941-964

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Handle: RePEc:eee:jmacro:v:30:y:2008:i:3:p:941-964
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