IDEAS home Printed from https://ideas.repec.org/a/fip/fedfpr/y2001imarx2.html
   My bibliography  Save this article

Simple monetary policy rules and exchange rate uncertainty

Author

Listed:
  • Kai Leitemo
  • Ulf Soderstrom

Abstract

We analyze the performance and robustness of some common simple rules for monetary policy in a new-Keynesian open economy model under different assumptions about the determination of the exchange rate. Adding the exchange rate to an optimized Taylor rule gives only slight improvements in terms of the volatility of important variables in the economy. Furthermore, although the rules including the exchange rate (and in particular, the real exchange rate) perform slightly better than the Taylor rule on average, they sometimes lead to very poor outcomes. Thus, the Taylor rule seems more robust to model uncertainty in the open economy.

Suggested Citation

  • Kai Leitemo & Ulf Soderstrom, 2001. "Simple monetary policy rules and exchange rate uncertainty," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  • Handle: RePEc:fip:fedfpr:y:2001:i:mar:x:2
    as

    Download full text from publisher

    File URL: http://www.frbsf.org/economics/conferences/0103/conf1.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-660, June.
    2. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
    3. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
    4. Taylor, John B., 1999. "The robustness and efficiency of monetary policy rules as guidelines for interest rate setting by the European central bank," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 655-679, June.
    5. Fabio Ghironi, 2000. "Alternative Monetary Rules for a Small Open Economy: The Case of Canada," Boston College Working Papers in Economics 466, Boston College Department of Economics, revised 30 Oct 2000.
    6. Richard Dennis, 2003. "Exploring the Role of the Real Exchange Rate in Australian Monetary Policy," The Economic Record, The Economic Society of Australia, vol. 79(244), pages 20-38, March.
    7. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
    8. 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.
    9. MacDonald, Ronald, 1990. "Are Foreign Exchange Market Forecasters "Rational"? Some Survey-Based Tests," The Manchester School of Economic & Social Studies, University of Manchester, vol. 58(3), pages 229-241, September.
    10. McCallum, Bennett T & Nelson, Edward, 2000. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 74-91, Winter.
    11. Cavaglia, Stefano & Verschoor, Willem F. C. & Wolff, Christian C. P., 1993. "Further evidence on exchange rate expectations," Journal of International Money and Finance, Elsevier, vol. 12(1), pages 78-98, February.
    12. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange rate pass-through into import prices: a macro or micro phenomenon?," Staff Reports 149, Federal Reserve Bank of New York.
    13. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters,in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
    14. Rudd, Jeremy & Whelan, Karl, 2005. "New tests of the new-Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1167-1181, September.
    15. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
    16. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April.
    17. Glenn D. Rudebusch, 2002. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Economic Journal, Royal Economic Society, vol. 112(479), pages 402-432, April.
    18. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 879-904, July.
    19. 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.
    20. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-153, March.
    21. McCallum, Bennett T., 1994. "A reconsideration of the uncovered interest parity relationship," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 105-132, February.
    22. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, Oxford University Press, vol. 104(1), pages 139-161.
    23. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters,in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc.
    24. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters,in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
    25. Leitemo, Kai & Söderström, Ulf, 2005. "Robust monetary policy in a small open economy," Research Discussion Papers 20/2005, Bank of Finland.
    26. Naug, Bjorn & Nymoen, Ragnar, 1996. " Pricing to Market in a Small Open Economy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(3), pages 329-350.
    27. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521104609, October.
    28. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-863, October.
    29. Obstfeld, Maurice & Rogoff, Kenneth, 2000. "New directions for stochastic open economy models," Journal of International Economics, Elsevier, vol. 50(1), pages 117-153, February.
    30. Swanson, Eric T., 2004. "Signal Extraction And Non-Certainty-Equivalence In Optimal Monetary Policy Rules," Macroeconomic Dynamics, Cambridge University Press, vol. 8(01), pages 27-50, February.
    31. William P. Osterberg, 2000. "New results on the rationality of survey measures of exchange-rate expectations," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 14-21.
    32. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
    33. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, University of Manchester, vol. 49(3), pages 211-228, September.
    34. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
    35. Adolfson, Malin, 2007. "Incomplete exchange rate pass-through and simple monetary policy rules," Journal of International Money and Finance, Elsevier, vol. 26(3), pages 468-494, April.
    36. Leitemo, Kai & Söderström, Ulf, 2008. "Robust monetary policy in a small open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3218-3252, October.
    37. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
    38. Alexius, Annika & Vredin, Anders, 1999. " Pricing-to-Market in Swedish Exports," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(2), pages 223-239, June.
    39. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
    40. 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.
    41. Sargent, Thomas J, 1978. "Estimation of Dynamic Labor Demand Schedules under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1009-1044, December.
    42. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 947-981, July.
    43. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
    44. Batini, Nicoletta & Harrison, Richard & Millard, Stephen P., 2003. "Monetary policy rules for an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 2059-2094.
    45. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
    46. Soderstrom, Ulf, 2002. " Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145.
    47. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    48. Ito, Takatoshi, 1990. "Foreign Exchange Rate Expectations: Micro Survey Data," American Economic Review, American Economic Association, vol. 80(3), pages 434-449, June.
    49. Batini, Nicoletta & Nelson, Edward, 2001. "Optimal horizons for inflation targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 891-910, June.
    50. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
    51. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
    52. Glenn D. Rudebusch, 2001. "Is The Fed Too Timid? Monetary Policy In An Uncertain World," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 203-217, May.
    53. Denise Côté & John Kuszczak & Jean-Paul Lam & Ying Liu & Pierre St-Amant, 2004. "The performance and robustness of simple monetary policy rules in models of the Canadian economy," Canadian Journal of Economics, Canadian Economics Association, vol. 37(4), pages 978-998, November.
    54. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
    55. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
    56. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    57. Jeffrey A. Frankel & Kenneth A. Froot, 1985. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers 1672, National Bureau of Economic Research, Inc.
    58. Kennan, John, 1979. "The Estimation of Partial Adjustment Models with Rational Expectations," Econometrica, Econometric Society, vol. 47(6), pages 1441-1455, November.
    59. Liu, Peter C. & Maddala, G. S., 1992. "Rationality of survey data and tests for market efficiency in the foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 11(4), pages 366-381, August.
    60. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Monetary policy ; Foreign exchange rates;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedfpr:y:2001:i:mar:x:2. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Federal Reserve Bank of San Francisco Research Library). General contact details of provider: http://edirc.repec.org/data/frbsfus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.