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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
Contact details of provider: Postal: The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden
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  1. Adolfson, Malin, 1996. "Exchange Rate Pass-Through to Swedish Import Prices," SSE/EFI Working Paper Series in Economics and Finance 123, Stockholm School of Economics.
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  13. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Series 0128, European Central Bank.
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  15. Adolfson, Malin, 2001. "Optimal Monetary Policy Delegation under Incomplete Exchange Rate Pass-Through," SSE/EFI Working Paper Series in Economics and Finance 477, Stockholm School of Economics.
  16. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  17. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
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  20. Alan Sutherland, 2002. "Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability," Discussion Paper Series, Department of Economics 200212, Department of Economics, University of St. Andrews.
  21. Adolfson, Malin, 2001. "Monetary Policy with Incomplete Exchange Rate Pass-Through," SSE/EFI Working Paper Series in Economics and Finance 476, Stockholm School of Economics.
  22. Jordi Galí & Tommaso Monacelli, 2004. "Monetary policy and exchange rate volatility in a small open economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra.
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  24. Kollmann, Robert, 2002. "Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles," CEPR Discussion Papers 3279, C.E.P.R. Discussion Papers.
  25. Sutherland, Alan, 2002. "International monetary policy coordination and financial market integration," Working Paper Series 0174, European Central Bank.
  26. Laurence Ball, 2000. "Policy Rules and External Shocks," Working Papers Central Bank of Chile 82, Central Bank of Chile.
  27. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  28. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  29. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
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  33. Naug, Bjorn & Nymoen, Ragnar, 1996. " Pricing to Market in a Small Open Economy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(3), pages 329-50.
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