Over the past decade, many developing nations have adopted inflation targeting within their monetary policy strategy, with varied approaches to exchange rate flexibility. This paper investigates if ...monetary policies in economies with high trade openness should integrate exchange rate movements in setting interest rates. Conventional micro-founded models suggest limited benefits from including exchange rates in policy rules. However, using a dynamic stochastic general equilibrium framework focused on Thailand, a small open economy with high trade openness, we find that responding to exchange rate changes with policy rates enhances welfare, more so than disregarding these fluctuations. Additionally, we observe that increased trade openness leads to a flattening of the Phillips curve and hence requires a stronger policy response to deviations from the inflation target. Our findings highlight the critical role of considering exchange rate movements and the degree of trade openness in formulating monetary policies.
Since the Global Financial Crisis, a lively debate has emerged regarding the monetary policy rule the central bank of a small open economy (SOE) follows and should follow. By identifying the monetary ...policy rule that best fits historical data and minimizes central bank loss functions, this study contributes to this debate. We estimate a medium-scale micro-founded SOE model under various monetary policy rules using Israeli data from 1994 to 2019. Our results indicate that the model achieves a better fit to historical data when assuming inflation targeting (IT) compared to nominal income targeting (NGDP). Given central bank goals, shock uncertainty, and limited information, NGDP targeting rules may have been more desirable over the last three decades than IT rules.
Monetary policy affects the degree of strategic complementarity in firms’ pricing decisions if it responds to the aggregate price level. In normal times, when monopolistic competitive firms increase ...their prices, the central bank raises interest rates, which lowers demand and creates an incentive for firms to reduce their prices. Thereby, monetary policy reduces the degree of strategic complementarities among firms’ pricing decisions and even turns prices into strategic substitutes if the effect of interest rates on demand is sufficiently strong. We show that this condition holds when monetary policy follows the Taylor principle. By contrast, if the equilibrium is indeterminate, because monetary policy violates the Taylor principle, or in a liquidity trap where monetary policy is restricted by the zero lower bound, pricing decisions are strategic complements. We discuss the consequences for dynamic adjustment processes after shocks and some policy implications.
The house price‐to‐income ratio (PIR) is widely used as an affordability indicator. This paper complements the cross‐sectionally focused literature by proposing a tractable model for the PIR ...dynamics. Our model predicts that the PIR is very persistent and is correlated to the lagged aggregate output. Cross‐country analysis confirms this prediction and provides evidence for a long‐term, positive, and significant relationship between PIR and aggregate production. Our results hint at the construction of an early warning system for housing market mispricing. Our tractable formulation of a stochastic money growth rule may carry independent research interest.
The effectiveness of an exchange rate based monetary policy rule for Singapore given the highly open nature of the economy has been empirically well documented in the literature. However, what is ...somewhat less recognized is that monetary policy in Singapore has historically been conducted in an asymmetric manner where there is willingness to allow for greater appreciation of the nominal effective exchange rate (NEER) during boom periods to curb inflation but not to implement a policy of depreciation during a downturn, i.e. a strong Singapore dollar (SSD) policy. We contribute to the literature by being one of the first to test the empirical validity of a SSD policy. We do so by estimating a Taylor style monetary policy rule (MPR) for Singapore with NEER as the main instrument of policy using monthly data for 2000 to 2019. Our empirical findings suggest that Singapore's MPR appears to react asymmetrically to inflation and output above a particular threshold but is predominantly concerned with inflation in the policy rule, offering evidence of a policy position consistent with SSD in that it allows for disproportionately higher NEER in boom periods.
Cet article porte sur le pass-through du taux d’intérêt monétaire sur le taux d’intérêt des crédits. L’objectif est d’analyser la façon dont le comportement de la banque centrale, représenté par une ...règle de Taylor, affecte la détermination du pass-through . Un modèle théorique en équilibre partiel est développé puis calibré pour la zone euro. Les résultats montrent que le degré de gradualisme de la politique monétaire et, de façon plus générale, les différentes sources d’inertie caractérisant la dynamique du taux du marché monétaire, affectent positivement l’ampleur du pass-through . De plus, le poids relatif de cette composante du pass-through associée aux inerties du taux du marché monétaire est d’autant plus important que les rigidités sur les taux d’intérêt des crédits sont fortes.Classification JEL : G21, E43.
Motivated by the institutional features of China's monetary policy, this paper aims at identifying the most data favored monetary policy rule for China within a dynamic stochastic general equilibrium ...(DSGE) model framework. In a canonical New-Keynesian DSGE model, we carry out a positive analysis by employing Bayesian methods to estimate three main categories of monetary policy rules, namely a Taylor-type interest rate rule, a money growth rule and an expanded Taylor rule with money. Based on China's quarterly data from 1996Q2 to 2015Q4, our estimation shows that the expanded Taylor rule obtains the best empirical fit to the data. Moreover, impulse responses and forecast error variance decompositions demonstrate that monetary policy rules with or without money provide very different implications for the policy behavior. Our results ultimately suggest that money has so far been more closely targeted than nominal interest rate and still plays an important role as a monetary policy target in China. Furthermore, a conventional Taylor-type interest rate rule is not good enough yet to describe China's monetary policy behavior.
•Taylor rule expanded with money fits Chinese data much better than a conventional Taylor rule.•Policy rules with or without money provide very different implications for China's monetary policy.•Money should be an indispensable policy target when a monetary policy rule is chosen for China.•Our results help to establish consensus on the simple monetary policy rule for China.•Our results provide some rationale of DSGE models used to evaluate China's monetary policy.
The Taylor rule incorporates several features of an optimal monetary policy, from the standpoint of at least one simple class of optimizing models. The response that it prescribes to fluctuations in ...inflation or the output gap tends to stabilize those variables, and stabilization of both variables in an appropriate goal, at least when the output gap is properly defined. Furthermore, the prescribed response to these variables counteracts instability due to self-fulfilling expectations. At the same time, the original formulation of the rule may be improved upon. Considerations call for further research to improve measurement of the natural rates of output and of interest, and to analyze the consequences of inertial rules in the context of more detailed models.
This paper studies the real exchange rate adjustment process in the baseline small open economy New-Keynesian framework. The paper shows that i) the version of the model with real shocks replicates ...the persistence and the hump-shaped dynamics of the real exchange rate observed in the data, and ii) the model cannot simultaneously match the observed dynamics of the real exchange rate and the close co-movement between the real and nominal currency returns. Thus, the baseline framework cannot fully capture the real exchange rate adjustment process.
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