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Trend Inflation and Exchange Rate Dynamics : A New Keynesian Approach

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  • Kano, Takashi
  • 加納, 隆

Abstract

This study examines the exchange rate implications of trend inflation within a two-country New Keynesian (NK) model. An NK Phillips curve generalized by trend inflation makes the inflation differential smoother, more persistent, and less sensitive to the real exchange rate. A Bayesian analysis with post-Bretton Woods data for Canada and the U.S. shows that the model’s equilibrium, which relies on Taylor rules with a persistent trend inflation shock and strong policy inertia, mimics empirical regularities in exchange rates that are difficult to reconcile within a standard NK model. Trend inflation helps explain the empirical puzzles of the exchange rate dynamics.

Suggested Citation

  • Kano, Takashi & 加納, 隆, 2021. "Trend Inflation and Exchange Rate Dynamics : A New Keynesian Approach," Discussion paper series HIAS-E-38, Hitotsubashi Institute for Advanced Study, Hitotsubashi University.
  • Handle: RePEc:hit:hiasdp:hias-e-38
    Note: December 2016 (revised February, 2021)
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    References listed on IDEAS

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    Cited by:

    1. Dudley Cooke & Engin Kara, 2018. "Can Trend Inflation Solve the Delayed Overshooting Puzzle?," Globalization Institute Working Papers 334, Federal Reserve Bank of Dallas.
    2. Cecion, Martina & Coenen, Günter & Gerke, Rafael & Le Bihan, Hervé & Motto, Roberto & Aguilar, Pablo & Ajevskis, Viktors & Giesen, Sebastian & Albertazzi, Ugo & Gilbert, Niels & Al-Haschimi, Alexander, 2021. "The ECB’s price stability framework: past experience, and current and future challenges," Occasional Paper Series 269, European Central Bank.

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    More about this item

    Keywords

    Real and Nominal Exchange Rates; Trend Inflation; New Keynesian Model; Bayesian analysis;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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