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Incomplete Exchange Rate Pass-Through and Simple Monetary Policy Rules

  • Adolfson, Malin


    (Research Department, Central Bank of Sweden)

This paper investigates the performance of various monetary rules 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. A direct exchange rate response improves welfare only if the other reaction coefficients, on inflation and output, are sub-optimal. However, an indirect exchange rate response, through a policy reaction to Consumer Price Index (CPI) inflation rather than to domestic inflation, is welfare enhancing. This result is independent of whether society values domestic or CPI inflation stabilization.

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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 136.

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Length: 36 pages
Date of creation: 01 Jun 2002
Date of revision:
Publication status: Forthcoming in Journal of International Money and Finance.
Handle: RePEc:hhs:rbnkwp:0136
Contact details of provider: Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Phone: 08 - 787 00 00
Fax: 08-21 05 31
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  1. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  2. Leitemo, Kai & Soderstrom, Ulf, 2005. "Simple monetary policy rules and exchange rate uncertainty," Journal of International Money and Finance, Elsevier, vol. 24(3), pages 481-507, April.
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  8. Sutherland, Alan, 2002. "Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability," CEPR Discussion Papers 3431, C.E.P.R. Discussion Papers.
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  10. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
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  14. Andrew T. Levin & Volker W. Wieland & John C. Williams, 1998. "Robustness of simple monetary policy rules under model uncertainty," Finance and Economics Discussion Series 1998-45, Board of Governors of the Federal Reserve System (U.S.).
  15. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
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  17. 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.
  18. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," SSE/EFI Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  19. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
  20. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  21. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  22. Gerlach, Stefan & Schnabel, Gert, 1999. "The Taylor Rule and Interest Rates in the EMU Area," CEPR Discussion Papers 2271, C.E.P.R. Discussion Papers.
  23. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy Rules for Inflation Targeting," NBER Working Papers 6512, National Bureau of Economic Research, Inc.
  24. 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.
  25. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  26. 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.
  27. Benigno, Gianluca & Benigno, Pierpaolo, 2003. "Designing targeting rules for international monetary policy cooperation," Working Paper Series 0279, European Central Bank.
  28. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  29. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
  30. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
  31. 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.
  32. Adolfson, Malin, 2002. "Implications of Exchange Rate Objectives under Incomplete Exchange Rate Pass-Through," Working Paper Series 135, Sveriges Riksbank (Central Bank of Sweden).
  33. Adolfson, Malin, 2001. "Monetary Policy with Incomplete Exchange Rate Pass-Through," Working Paper Series 127, Sveriges Riksbank (Central Bank of Sweden).
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