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Optimal exchange rate policy in a low interest rate environment

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  • Pavasuthipaisit, Robert

Abstract

This paper examines optimal exchange policy when nominal interest rates are unusually low, as experienced by several Asian economies and Japan since July 2006. The paper finds that in such environments, it is optimal to create a nominal depreciation to offset contractionary disturbances. However, the limited scope of monetary policy easing may compromise the ability of the central bank to create a nominal depreciation especially if the central bank makes decisions on monetary policy making on a discretionary basis. In order to successfully create a nominal depreciation, the central bank needs to rely on the expectations channel, by making a credible promise to keep its currency weak going forward. Finally, trade liberalization, by enhancing the role of the exchange rate channel on the transmission mechanism, may allow the central bank to achieve lower average inflation.

Suggested Citation

  • Pavasuthipaisit, Robert, 2007. "Optimal exchange rate policy in a low interest rate environment," MPRA Paper 3596, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:3596
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    File URL: https://mpra.ub.uni-muenchen.de/3596/1/MPRA_paper_3596.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Zero lower bound; liquidity trap; exchange rate policy; open-economy macroeconomics;

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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