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Should the ECB respond to exchange rates?

  • Petri Mäki-Fränti

    (Department of Economics and Accounting, University of Tampere, Finland)

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    Using a structural, quantitative macro model, this paper investigates benefits of including the real exchange rate of the euro into the monetary policy rule of the European Central Bank (ECB). The problem is considered from viewpoints of both the whole monetary union and a single member state with a national economy more open and facing different structural shocks than the union economy on average. According to the results, the union would benefit more from the exchange rate stabilisation than the member state, when the exchange rate response is set to minimise the loss function calculated for the whole monetary union. Only with rather high exchange rate response by the central bank, would the gain for the member state be larger. Moreover, also when it comes to central bankʼs responses to inflation and output, the common monetary policy does not fit the member state very well. The union as a whole would benefit from central bankʼs relatively stronger response to output than inflation, while for the member state the weights of inflation and output in the policy rule should be set the other way round.

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    File URL: http://www.taloustieteellinenyhdistys.fi/images/stories/fep/fep12005_makifranti.pdf
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    Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

    Volume (Year): 18 (2005)
    Issue (Month): 1 (Spring)
    Pages: 31-46

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    Handle: RePEc:fep:journl:v:18:y:2005:i:1:p:31-46
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    1. Laurence Ball, 1998. "Policy Rules for Open Economies," RBA Research Discussion Papers rdp9806, Reserve Bank of Australia.
    2. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
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