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Exploring the role of the real exchange rate in Australian monetary policy

  • Richard Dennis

An important issue in small open-economies is whether policymakers should respond to exchange rate movements when they formulate monetary policy. Micro-founded models tend to suggest that there is little to be gained from responding to exchange rate movements, and the literature has largely concluded that such a response is unnecessary, or even undesirable (Taylor, 2001). This paper examines this issue using an estimated model of the Australian economy. In contrast to micro-founded models, according to this model policymakers should allow for movements in the real exchange rage and the terms-of-trade when they set interest rates. Further, taking real exchange rate movements into account appears even more important with price level targeting than with inflation targeting.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2002-19.

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Date of creation: 2002
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Publication status: Published in Economic Record, Vol. 79, pp. 20-38, March 2003
Handle: RePEc:fip:fedfwp:2002-19
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