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Federal Reserve Bank of San Francisco
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Optimal simple targeting rules for small open economies
Richard Dennis

This paper solves for optimal policy rules in a stylized small open economy model under a spectrum of targeting regimes. These policy reaction functions are presented as feedback rules highlighting the dominant state variables in each rule. Optimal simple rules - rules that exploit a reduced information set - are explored to assess how much is lost when information is excluded from the optimal state-contingent rule. For the model analyzed we find that some optimal simple rules can approximate reasonably well the optimal state-contingent rule, these simple rules contain the real exchange rate. Knowing which variables underpin the performance of the optimal state-contingent rule is important for developing simple, robust, rules with good stabilizing properties.

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Richard Dennis, Optimal simple targeting rules for small open economies, Federal Reserve Bank of San Francisco, Working Paper Series 2000-20, 2000.
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Keywords: Econometric models ; Foreign exchange rates ; Inflation (Finance) ; Taylor's rule
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