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The advantage of transparent instruments of monetary policy

  • Andrew Atkeson
  • Patrick J. Kehoe

A classic question in international economics is whether it is better to use the exchange rate or the money growth rate as the instrument of monetary policy. A common argument is that the exchange rate has a natural advantage since exchange rates provide signals of policymakers? actions that are easier to monitor than those provided by money growth rates. We formalize this argument in a simple model in which the government chooses which instrument it will use to target inflation. In it, the exchange rate is more transparent than the money growth rate in that the exchange rate is easier for the public to monitor. We find that the greater transparency of the exchange rate regime makes it easier to provide the central bank with incentives to pursue good policies and hence gives this regime a natural advantage over the money regime.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 614.

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Date of creation: 2001
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Handle: RePEc:fip:fedmwp:614
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  1. Green, Edward J & Porter, Robert H, 1984. "Noncooperative Collusion under Imperfect Price Information," Econometrica, Econometric Society, vol. 52(1), pages 87-100, January.
  2. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
  3. Faust, J. & Svensson, L.E.O., 1999. "The Equilibrium Degree of Transparency and Control in Monetary Policy," Papers 669, Stockholm - International Economic Studies.
  4. Faust, Jon & Svensson, Lars E O, 2001. "Transparency and Credibility: Monetary Policy with Unobservable Goals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 369-97, May.
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  7. Abreu, Dilip, 1986. "Extremal equilibria of oligopolistic supergames," Journal of Economic Theory, Elsevier, vol. 39(1), pages 191-225, June.
  8. Abreu, Dilip & Pearce, David & Stacchetti, Ennio, 1986. "Optimal cartel equilibria with imperfect monitoring," Journal of Economic Theory, Elsevier, vol. 39(1), pages 251-269, June.
  9. Canavan, Chris & Tommasi, Mariano, 1997. "On the credibility of alternative exchange rate regimes," Journal of Development Economics, Elsevier, vol. 54(1), pages 101-122, October.
  10. V.V. Chari & Patrick J. Kehoe & Edward C. Prescott, 1988. "Time consistency and policy," Staff Report 115, Federal Reserve Bank of Minneapolis.
  11. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  12. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  13. Stefania Albanesi & V. V. Chari & Lawrence J. Christiano, 2003. "How severe is the time-inconsistency problem in monetary policy?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 17-33.
  14. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
  15. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
  16. Carlos E. Zarazaga, 1993. "Hyperinflations and moral hazard in the appropriation of seigniorage," Working Papers 93-26, Federal Reserve Bank of Philadelphia.
  17. Chang, Roberto, 1998. "Credible Monetary Policy in an Infinite Horizon Model: Recursive Approaches," Journal of Economic Theory, Elsevier, vol. 81(2), pages 431-461, August.
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