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 can outperform a Taylor rule in managing macroeconomics fluctuations and in achieving higher welfare. The differences between the rules are driven by: (i) the paths of the nominal exchange rate and the 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 economies, which are very open, which are more exposed to foreign shocks, or in which domestic and foreign goods are highly substitutable.

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

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: 2021-09-30

Number: 2017-028

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

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