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Do Central Banks Respond to Exchange Rate Movements? Some New Evidence from Structural Estimation

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  • Wei Dong

Abstract

This paper investigates the impact of exchange rate movements on the conduct of monetary policy in Australia, Canada, New Zealand and the United Kingdom. We develop and estimate a structural general equilibrium two-sector model with sticky prices and wages and limited exchange rate pass-through. Different specifications for the monetary policy rule and the real exchange rate process are examined. The results indicate that the Reserve Bank of Australia, the Bank of Canada and the Bank of England paid close attention to real exchange rate movements, whereas the Reserve Bank of New Zealand did not seem to incorporate exchange rate movements explicitly into their policy rule. With a higher degree of intrinsic inflation persistence, the central bank of New Zealand seems less concerned about future inflation pressure induced by current exchange rate movements. In addition, the structure of the shocks driving inflation and output variations in New Zealand is such that it may be sufficient for the Reserve Bank of New Zealand to only respond to exchange rate movements indirectly through stabilizing inflation and output.

Suggested Citation

  • Wei Dong, 2008. "Do Central Banks Respond to Exchange Rate Movements? Some New Evidence from Structural Estimation," Staff Working Papers 08-24, Bank of Canada.
    • Handle: RePEc:bca:bocawp:08-24
    DOI: 10.34989/swp-2008-24
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    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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