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On the Reasons Behind Fear of Floating: Pass-through Effects vs. Contractionary Depreciations

  • Juan F. Castro

Based on a simple open economy framework, this analysis rationalizes the existence of “fear of floatingâ€-type responses and uncovers some important implications about to role of pass-through effects and contractionary depreciations. By examining how the optimal monetary response varies when altering the effects of the real exchange rate on output and inflation, this analysis reveals the existence of non-linearities when we allow for contractionary depreciations. In particular, an increase in the pass-through coefficient may well imply the need to tighten or relax the monetary stance depending on how contractionary real depreciations are. These findings may help to understand the empirical results where pass-through effects have failed to appear significant when accounting for low exchange rate and high interest rate variability. They also reveal the complications that arise when conducting monetary policy in a partially dollarized economy.

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Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 268.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:268
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  1. Reinhart, Carmen & Calvo, Guillermo, 2001. "Fixing for your life," MPRA Paper 13873, University Library of Munich, Germany.
  2. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
  3. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  4. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  5. Assaf Razin & Chi-Wa Yuen, 2001. "The "New Keynesian" Phillips Curve: Closed Economy vs. Open Economy," NBER Working Papers 8313, National Bureau of Economic Research, Inc.
  6. Eduardo Moron & Juan F. Castro, 2002. "Uncovering Central Bank Monetary Policy Objectives: Going Beyond Fear of Floating," Macroeconomics 0205002, EconWPA.
  7. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
  8. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Closed versus Open Economies: An Integrated Approach," NBER Working Papers 8604, National Bureau of Economic Research, Inc.
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