Central Bank Learning, Terms of Trade Shocks & Currency Risk: Should Exchange Rate Volatility Matter for Monetary Policy?
This paper examines the role of interest rate policy in a small open economy subject to terms of trade shocks and time-varying currency risk responding to domestic exchange rate volatility. The private sector makes optimal decisions in an intertemporal non-linear setting with rational,forward-looking expectations. In contrast,the monetary authority practices least-squares learning about the evolution of inflation, output growth, and exchange rate depreciation in alternative policy scenarios. Interest rates are set by linear quadratic optimization, with the objectives for inflation, output growth, or depreciation depending on current conditions. The simulation results show that the preferred stance is one which targets inflation and growth, not inflation only nor inflation, growth and depreciation. Including exchange rate changes as targets significantly increases output variability, but marginally reduces inflation variability.
|Date of creation:||01 Oct 2001|
|Contact details of provider:|| Postal: Boston College, 140 Commonwealth Avenue, Chestnut Hill MA 02467 USA|
Web page: http://fmwww.bc.edu/EC/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
- Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-137, February.
- Duffy, John & McNelis, Paul D., 2001.
"Approximating and simulating the stochastic growth model: Parameterized expectations, neural networks, and the genetic algorithm,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 25(9), pages 1273-1303, September.
- Paul McNelis & John Duffy, 1998. "Approximating and Simulating the Stochastic Growth Model: Parameterized Expectations, Neural Networks, and the Genetic Algorithm," GE, Growth, Math methods 9804004, EconWPA, revised 14 May 1998.
- L.J. Christiano & C.J. Gust, 1999. "Taylor Rules in a Limited Participation Model," DNB Staff Reports (discontinued) 33, Netherlands Central Bank.
- Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor rules in a limited participation model," Working Paper Series WP-99-3, Federal Reserve Bank of Chicago.
- Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor rules in a limited participation model," Working Paper 9902, Federal Reserve Bank of Cleveland.
- Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor Rules in a Limited Participation Model," NBER Working Papers 7017, National Bureau of Economic Research, Inc.
- Chris Ryan & Christopher Thompson, 2000. "Inflation Targeting and Exchange Rate Fluctuations in Australia," RBA Research Discussion Papers rdp2000-06, Reserve Bank of Australia.
- Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
- Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
- Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
- Bennett T. McCallum, 2000. "Theoretical analysis regarding a zero lower bound on nominal interest rates," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 870-935.
- McCallum, Bennett T, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 870-904, November.
- Bennett T. McCallum, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," NBER Working Papers 7677, National Bureau of Economic Research, Inc.
- den Haan, Wouter J & Marcet, Albert, 1990. "Solving the Stochastic Growth Model by Parameterizing Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 31-34, January.
- Wouter Denhaan & Albert Marcet, 1990. "FORTRAN code for Simulation Parameterized Expecations Algorithm," QM&RBC Codes 57, Quantitative Macroeconomics & Real Business Cycles.
- Wright, Brian D & Williams, Jeffrey C, 1982. "The Economic Role of Commodity Storage," Economic Journal, Royal Economic Society, vol. 92(367), pages 596-614, September.
- Judd, Kenneth L., 1996. "Approximation, perturbation, and projection methods in economic analysis," Handbook of Computational Economics,in: H. M. Amman & D. A. Kendrick & J. Rust (ed.), Handbook of Computational Economics, edition 1, volume 1, chapter 12, pages 509-585 Elsevier.
- 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.
- Hans M. Amman & David A. Kendrick, . "Computational Economics," Online economics textbooks, SUNY-Oswego, Department of Economics, number comp1.
- Christiano, Lawrence J, 2000. "Comment on Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 905-930, November. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:boc:bocoec:509. 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: (Christopher F Baum)
If references are entirely missing, you can add them using this form.