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Money Supply Rules and Exchange Rate Dynamics

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  • Juha Tervala

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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    File URL: http://www.ace-economics.fi/kuvat/dp62.pdf
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    References listed on IDEAS

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    1. Bjørnland, Hilde C., 2009. "Monetary policy and exchange rate overshooting: Dornbusch was right after all," Journal of International Economics, Elsevier, vol. 79(1), pages 64-77, September.
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    More about this item

    Keywords

    Monetary policy rules; open economy macroeconomics; exchange rate;
    All these keywords.

    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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