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

  • Wei Dong
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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.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp08-24.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 08-24.

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Length: 46 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:bca:bocawp:08-24
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