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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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  19. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
  20. 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.
  21. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  22. Sutherland, Alan, 2005. "Incomplete pass-through and the welfare effects of exchange rate variability," Journal of International Economics, Elsevier, vol. 65(2), pages 375-399, March.
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  27. 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.
  28. Lane, P, 1999. "The New Open Economy Macroeconomics: A Survey," Trinity Economics Papers 993, Trinity College Dublin, Department of Economics.
  29. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
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  35. 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.
  36. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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