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Exchange Rates and Monetary Policy in Emerging Market Economies

  • Michael B. Devereux

    (University of British Columbia)

  • Philip R. Lane

    (Trinity College Dublin)

This paper investigates the effects of exchange rate regimes and alternative monetary policy rules for an emerging market economy that is subject to a volatile external environment in the form of shocks to world interest rates, world prices and the terms of trade. Our model allows for the economy to be subject to external financing risk-premia associated with domestic net worth. We find that the particular monetary policy rule being followed is as important as whether the exchange rate is fixed or flexible. In general, there is a case for exchange rate flexibility under all shocks, but as constraints on external financing become more important, the relative benefits of monetary rules that allow for floating exchange rates tend to diminish. The benefit of exchange rate flexibility under terms of trade disturbances is quite minor, whether or not external financing constraints are important. In application to the economy of Thailand, we find that the major shocks hitting that economy come from the terms of trade. As a result, our simulation results suggest that for Thailand, the degree of exchange rate flexibility in monetary policy is likely to have only minor consequences for output stability.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 072000.

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Length: 36 pages
Date of creation: Oct 2000
Date of revision:
Handle: RePEc:hkm:wpaper:072000
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  1. Devereux, Michael B & Lane, Philip R., 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEPR Discussion Papers 2874, C.E.P.R. Discussion Papers.
  2. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 745-75, August.
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  9. Banerjee, Abhijit & Bacchetta, Philippe & Aghion, Philippe, 2001. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," Scholarly Articles 4554218, Harvard University Department of Economics.
  10. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
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  12. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
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  24. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
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  26. Mankiw, N Gregory & Summers, Lawrence H, 1986. "Money Demand and the Effects of Fiscal Policies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(4), pages 415-29, November.
  27. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
  28. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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