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Money Supply Rules and Exchange Rate Dynamics

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  • Juha Tervala

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Abstract

This paper examines the implications of monetary policy rules for exchange rate dynamics. I extend a standard New Open Economy Macroeconomics model with the introduction of a simple money supply rule, whereby central banks change their monetary policy if output diverges from potential output or if inflation diverges from the target inflation. A key result is that, in the case of permanent technology and monetary shocks, the nominal exchange rate does not follow a random walk; instead, the exchange rate undershoots its long-run value. An undershooting of the exchange rate derives from the active monetary policy that both countries conduct.

Suggested Citation

  • Juha Tervala, 2010. "Money Supply Rules and Exchange Rate Dynamics," Discussion Papers 62, Aboa Centre for Economics.
  • Handle: RePEc:tkk:dpaper:dp62
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    Cited by:

    1. Works, Richard Floyd, 2016. "Econometric modeling of exchange rate determinants by market classification: An empirical analysis of Japan and South Korea using the sticky-price monetary theory," MPRA Paper 76382, University Library of Munich, Germany.

    More about this item

    Keywords

    Monetary policy rules; open economy macroeconomics; exchange rate;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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