Working Paper Revision

Managing Macroeconomic Fluctuations with Flexible Exchange Rate Targeting

Abstract: We show that a monetary policy rule that uses the exchange rate to stabilize the economy outperforms a Taylor rule in managing macroeconomics fluctuations and in achieving higher welfare. The differences between the rules are driven by: (i) the path of the nominal exchange rate and interest rate under each rule, and (ii) time variation in the risk premium, which leads to deviations from uncovered interest parity. These differences are larger in very open economies, more exposed to foreign shocks, and in which domestic and foreign goods are highly substitutable.

Keywords: Time-Varying Risk Premium; Exchange Rate Management; Welfare; Monetary Policy Rules;

JEL Classification: E52; F31; F41;

https://doi.org/10.20955/wp.2017.028

Status: Published in Journal of Economic Dynamics and Control

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2019-11-05

Number: 2017-28

Note: Publisher DOI: https://doi.org/10.1016/j.jedc.2022.104311

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