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Exchange Rate Targeting in a Small Open Economy

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  • Mette Ersbak Bang Nielsen

Abstract

The paper develops a New Keynesian Small Open Economy Model charac- terized by external habit formation and Calvo price setting with dynamic inflation updating. The model is used to analyze the e¤ect of nominal ex- change rate targeting on optimal policy and impulse responses. It is found that even moderate exchange rate concerns are capable of changing both sign and magnitude of the optimal instrument response to variables, and that whether the concern is with respect to the level or first di¤erence has much impact on monetary policy. Also, the cost of exchange rate stabilization in terms of output and inflation is evident in the model, and impulse responses under moderate exchange rate targeting are not simple combinations of those under a float and a regime that cares almost only for meeting the exchange rate target.

Suggested Citation

  • Mette Ersbak Bang Nielsen, 2006. "Exchange Rate Targeting in a Small Open Economy," Borradores de Economia 367, Banco de la Republica de Colombia.
    • Handle: RePEc:bdr:borrec:367
    DOI: 10.32468/be.367
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    References listed on IDEAS

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    1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
    2. Moron, Eduardo & Winkelried, Diego, 2005. "Monetary policy rules for financially vulnerable economies," Journal of Development Economics, Elsevier, vol. 76(1), pages 23-51, February.
    3. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    4. Tommaso Monacelli, 2003. "Monetary Policy in a Low Pass-Through Environment," Working Papers 228, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    5. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    6. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    7. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(3), pages 707-734.
    8. Alessandro Flamini, 2003. "CPI Inflation Targeting and Exchange Rate Pass-through," Macroeconomics 0306017, University Library of Munich, Germany.
    9. 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.
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    Cited by:

    1. Javier Guillermo Gómez, 2006. "Capital Flows and Monetary Policy," Borradores de Economia 2097, Banco de la Republica.

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    More about this item

    Keywords

    Flexible inflation targeting; exchange rates; fear of floating;
    All these keywords.

    JEL classification:

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

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