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Managed floating as a monetary policy strategy

  • Bofinger, Peter
  • Wollmershäuser, Timo

Although there seems to be a broad consensus among economists that purely floating or completely fixed exchange rates (the so-called corner solutions) are the only viable alternatives of exchange rate management. many countries do not behave according to this paradigm and adopt a strategy within the broad spectrum of exchange rate regimes that is limited by the two corner solutions. Many of these intermediate regimes are characterized by significant foreign exchange market interventions and a certain degree of exchange rate flexibility with non-preannounced exchange rate targets. While academic research in this area usually concentrates on some specific aspects of intermediate regimes (such as the effectiveness of interventions or institutional aspects), managed floating has rarely been analyzed as a comprehensive monetary policy strategy. In this paper, we present a monetary policy framework in which central banks simultaneously use the exchange rate and the interest rate as operating targets of monetary policy. We explain the mechanics of foreign exchange market interventions and sterilization and we explain why a central bank has an interest of controlling simultaneously the two operating targets. We derive the monetary policy rates for the two operating targets from a simple open economy macro model in which the uncovered interest parity condition and the monetary conditions index play a central role.

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Paper provided by University of Munich, Department of Economics in its series Munich Reprints in Economics with number 20206.

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Date of creation: 2003
Date of revision:
Publication status: Published in Economics of Planning 2 36(2003): pp. 81-109
Handle: RePEc:lmu:muenar:20206
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  1. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
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  5. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
  6. Lars E.O Svensson, 2002. "Monetary policy and real stabilization," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 261-312.
  7. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  8. Bennett T. McCallum, 2000. "Theoretical analysis regarding a zero lower bound on nominal interest rates," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 870-935.
  9. Sarno, Lucio & Taylor, Mark P, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective, and, If So, How Does It Work?," CEPR Discussion Papers 2690, C.E.P.R. Discussion Papers.
  10. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
  11. Martin D. D. Evans & Richard K. Lyons, 2003. "Are Different-Currency Assets Imperfect Substitutes?," CESifo Working Paper Series 978, CESifo Group Munich.
  12. Bofinger, Peter & Wollmershäuser, Timo, 2001. "Managed floating: Understanding the new international monetary order," W.E.P. - Würzburg Economic Papers 30, University of Würzburg, Chair for Monetary Policy and International Economics.
  13. Anna J. Schwartz, 2000. "The Rise and Fall of Foreign Exchange Market Intervention," NBER Working Papers 7751, National Bureau of Economic Research, Inc.
  14. Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers 118, Princeton University, Department of Economics, Center for Economic Policy Studies..
  15. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  16. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March.
  17. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  18. Lawrence H. Summers, 2000. "International Financial Crises: Causes, Prevention, and Cures," American Economic Review, American Economic Association, vol. 90(2), pages 1-16, May.
  19. Jorge Iván Canales Kriljenko, 2003. "Foreign Exchange Intervention in Developing and Transition Economies; Results of a Survey," IMF Working Papers 03/95, International Monetary Fund.
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