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Learning under Fear of Floating

Author

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  • Bigio, Saki

    (Department of Economics, New York University)

Abstract

Cross-country evidence suggests that during recent years a large fraction of developing countries seem to began to overcome fear of oating, i.e., a lower relative volatility of exchange rates to monetary policy instruments. To explain this trend, we build a model that describes the behavior of Central Banks in developing countries under uncertainty and fear of misspeci cation about the e ects of exchange rate depreciations. The Central Bank is uncertain about two sub-models which di er in that exchange rate depreciations can cause output either to expand (textbook e ect) or contract (balance sheet e ect). Optimal policy within the second sub-model is consistent with fear of floating. A feature of fear of oating is that, by preventing sizeable exchange rate swings, Central Banks could loose valuable information useful to distinguish among models. We describe how the Central Bank's the evolution of the prior depends on the optimal policy and viceversa. We conclude that the trend towards less fear of floating may not be explained by Bayesian or robust policies because it would have been too quick to explain the data. However, if there was a parameter change affecting many countries during the early 2000's, the model generates the observed pattern.

Suggested Citation

  • Bigio, Saki, 2009. "Learning under Fear of Floating," Working Papers 2009-004, Banco Central de Reserva del Perú.
  • Handle: RePEc:rbp:wpaper:2009-004
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    References listed on IDEAS

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    Cited by:

    1. Thomas Windberger & Jesus Crespo Cuaresma & Janette Walde, 2012. "Dirty floating and monetary independence in Central and Eastern Europe - The role of structural breaks," Working Papers 2012-21, Faculty of Economics and Statistics, University of Innsbruck.
    2. Ludwig, Alexander & Zimper, Alexander, 2014. "Biased Bayesian learning with an application to the risk-free rate puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 39(C), pages 79-97.

    More about this item

    Keywords

    Balance Sheet Effect; Fear of Floating; Model Uncertainty; Learning; Monetary Policy; Policy Experimentation; Robustness;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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