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Optimal Monetary Policy Delegation under Incomplete Exchange Rate Pass-Through

  • Adolfson, Malin

    ()

    (Dept. of Economics, Stockholm School of Economics)

The central bank’s optimal objective function is analyzed in a small open economy model allowing for incomplete exchange rate pass-through. The results indicate that social welfare can only be marginally improved by including an explicit exchange-rate term in the delegated objective function, irrespective of the degree of pass-through. An implicit response to the exchange rate, through Consumer Price Index (CPI) inflation targeting is, however, beneficial. Welfare can, moreover, be enhanced by appointing a central banker with a greater preference for interest rate smoothing than that of the society, as a result of surpassing some of the stabilization bias arising under a discretionary policy. Consequently, there are welfare gains from monetary policy inertia. The optimal degree of interest rate smoothing is increasing in the degree of pass-through.

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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 477.

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Length: 37 pages
Date of creation: 31 Oct 2001
Date of revision:
Handle: RePEc:hhs:hastef:0477
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