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Monetary-Exchange Rate Policy and Current Account Dynamics

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  • Malik, Hamza

Abstract

A dynamic stochastic general equilibrium monetary model with incomplete and imperfect asset markets, monopolistic competition and staggered nominal price rigidities is developed to shed light on the role of exchange rate and its relation with current account dynamics in the formulation of monetary-exchange rate policies. The paper shows that because of incomplete risk sharing, due to incomplete asset markets, the dynamic relationship between real exchange rate and net foreign assets affect the behaviour of domestic inflation and aggregate output. This, in turn, implies that the optimal monetary policy entail a response to net foreign asset position or the real exchange rate gap defined as the difference between actual real exchange rate and the value that would prevail with flexible prices and complete asset markets. In comparing the performance of alternative monetary-exchange rate policy rules, an interesting and fairly robust result that stands out is that ‘dirty floating’ out-performs flexible exchange rate regime with domestic inflation targeting.

Suggested Citation

  • Malik, Hamza, 2005. "Monetary-Exchange Rate Policy and Current Account Dynamics," MPRA Paper 455, University Library of Munich, Germany, revised Sep 2006.
  • Handle: RePEc:pra:mprapa:455
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    2. Ali, Syed Zahid & Anwar, Sajid, 2011. "Supply-side effects of exchange rates, exchange rate expectations and induced currency depreciation," Economic Modelling, Elsevier, vol. 28(4), pages 1650-1672, July.
    3. Hisao Kumamoto & Masao Kumamoto, 2017. "Currency Substitution and Monetary Policy Effects: The Case of Latin American Countries," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(2), pages 32-45, February.

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    More about this item

    Keywords

    optimal monetary policy; incomplete asset markets; net foreign assets; current account dynamics; inflation targeting; exchange rate policy;
    All these keywords.

    JEL classification:

    • 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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