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Optimal Simple Monetary Policy Rules in a Small Open Economy with Exchange Rate Imperfections

The paper addresses whether or not the exchange rate or some other dimension of the external side of the economy should form an integral part of the monetary rule for a small open economy (SOE) in which the central bank faces data deficiencies. Under a number of information scenarios, the model’s simulations suggest that some reflection of the external environment facing the SOE—either the real exchange rate gap and/or the law of one price gap—is needed to improve monetary policy performance. When the money rule includes both interest rate smoothing and the real exchange rate (or law of one price gap), the relative welfare gain from their inclusion increases as the monetary authorities loses access to more current and reliable information.

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File URL: http://www.carleton.ca/economics/wp-content/uploads/cep08-03.pdf
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Paper provided by Carleton University, Department of Economics in its series Carleton Economic Papers with number 08-03.

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Length: 37 pages
Date of creation: 01 Aug 2008
Date of revision:
Publication status: Published: Carleton Economic Papers
Handle: RePEc:car:carecp:08-03
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  1. Nicoletta Batini & Richard Harrison & Stephen P. Millard, 2001. "Monetary policy rules for an open economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  6. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
  7. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
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  9. Jordi Gali & Tommaso Monacelli, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," NBER Working Papers 8905, National Bureau of Economic Research, Inc.
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  12. Sutherland, Alan, 2002. "Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability," CEPR Discussion Papers 3431, C.E.P.R. Discussion Papers.
  13. Charles Engel, 2003. "Expenditure Switching and Exchange-Rate Policy," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 231-300 National Bureau of Economic Research, Inc.
  14. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  15. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Series 0128, European Central Bank.
  16. 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.
  17. Jinill Kim & Sunghyun Kim & Ernst Schaumburg & Christopher A. Sims, 2003. "Calculating and using second order accurate solutions of discrete time dynamic equilibrium models," Finance and Economics Discussion Series 2003-61, Board of Governors of the Federal Reserve System (U.S.).
  18. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  19. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
  20. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  21. 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.
  22. Nooman Rebei & Steve Ambler & Ali Dib, 2004. "Optimal Taylor Rules in an Estimated Model of a Small Open Economy," Computing in Economics and Finance 2004 125, Society for Computational Economics.
  23. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  24. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  25. 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.
  26. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  27. Laxton, Douglas & Pesenti, Paolo, 2003. "Monetary rules for small, open, emerging economies," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1109-1146, July.
  28. Ireland, Peter N., 2001. "Sticky-price models of the business cycle: Specification and stability," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 3-18, February.
  29. Lane, Philip R., 1999. "The New Open Economy Macroeconomics: a Survey," CEPR Discussion Papers 2115, C.E.P.R. Discussion Papers.
  30. Charles Engel, 1992. "Real Exchange Rates and Relative Prices: An Empirical Investigation," NBER Working Papers 4231, National Bureau of Economic Research, Inc.
  31. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  32. 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.
  33. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  34. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  35. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, June.
  36. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
  37. Michael Woodford, 2001. "Inflation Stabilization and Welfare," NBER Working Papers 8071, National Bureau of Economic Research, Inc.
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