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Incomplete Exchange Rate Pass-Through and Simple Monetary Policy Rules

  • Adolfson, Malin

    ()

    (Dept. of Economics, Stockholm School of Economics)

The performance of various monetary rules is investigated in an open economy with incomplete exchange rate pass-through. Implementing monetary policy through an exchange-rate augmented policy rule does not improve social welfare compared to using an optimized Taylor rule, irrespective of the degree of pass-through. However, an indirect exchange rate response, through a policy reaction to Consumer Price Index (CPI) inflation rather than to domestic inflation, is welfare enhancing in all pass-through cases. This result is moreover independent of whether society values domestic or CPI inflation stabilization. The only case where a direct real exchange rate response is slightly welfare improving occurs when the other reaction coefficients, on inflation and output, are sub-optimal.

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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 478.

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Length: 30 pages
Date of creation: 31 Oct 2001
Date of revision:
Handle: RePEc:hhs:hastef:0478
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The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden

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