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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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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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  19. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  20. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
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  36. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
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