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Implications of Exchange Rate Objectives under Incomplete Exchange Rate Pass-Through

Author

Listed:
  • Adolfson, Malin

    (Research Department, Central Bank of Sweden)

Abstract
This paper analyzes the central bank’s optimal objective function in a small open economy model allowing for incomplete exchange rate pass-through. The results indicate that there are welfare gains from different types of monetary policy inertia. The welfare improvements of exchange rate stabilization are, however, dependent on the degree of discretionary stabilization bias. If the stabilization bias has been mitigated through a low weight on output stabilization social welfare can not be improved by inclusion of an explicit exchange rate term in the delegated objective function, irrespective of the degree of pass-through. Welfare can, though, be enhanced by appointing a central banker with greater preference for interest rate smoothing than that of society. The optimal degree of interest rate smoothing is increasing in the degree of pass-through.

Suggested Citation

  • Adolfson, Malin, 2002. "Implications of Exchange Rate Objectives under Incomplete Exchange Rate Pass-Through," Working Paper Series 135, Sveriges Riksbank (Central Bank of Sweden).
    • Handle: RePEc:hhs:rbnkwp:0135
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    File URL: http://www.riksbank.com/upload/6743/wp_135.pdf
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    References listed on IDEAS

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    1. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(1), pages 147-180.
    2. Campa, Jose M. & Goldberg, Linda S., 2002. "Exchange rate pass-through into import prices: A macro or micro phenomenon?," IESE Research Papers D/475, IESE Business School.
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    5. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
    6. Adolfson, Malin, 2001. "Monetary Policy with Incomplete Exchange Rate Pass-Through," SSE/EFI Working Paper Series in Economics and Finance 476, Stockholm School of Economics.
    7. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    8. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
    9. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156, National Bureau of Economic Research, Inc.
    10. Benigno, Pierpaolo & Benigno, Gianluca, 2001. "Price Stability as a Nash Equilibrium in Monetary Open-Economy Models," CEPR Discussion Papers 2757, C.E.P.R. Discussion Papers.
    11. Malin Adolfson, 1997. "Exchange rate pass-through to Swedish import prices," Finnish Economic Papers, Finnish Economic Association, vol. 10(2), pages 81-98, Autumn.
    12. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
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    Citations

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    Cited by:

    1. Kirdan Lees, 2003. "The stabilisation problem: the case of New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2003/08, Reserve Bank of New Zealand.
    2. Adolfson, Malin, 2007. "Incomplete exchange rate pass-through and simple monetary policy rules," Journal of International Money and Finance, Elsevier, vol. 26(3), pages 468-494, April.
    3. Lees, Kirdan, 2007. "How large are the gains to commitment policy and optimal delegation for New Zealand?," Journal of Macroeconomics, Elsevier, vol. 29(4), pages 959-975, December.
    4. Martins Bitans, 2004. "Pass-Through of Exchange Rates to Domestic Prices in East European Countries and the Role of Economic Enviroment," Working Papers 2004/04, Latvijas Banka.
    5. Timothy Kam, 2003. "Optimal Flexible Inflation Targeting, Interest-rate Smoothing and the Open Economy," Economics Discussion / Working Papers 03-26, The University of Western Australia, Department of Economics.
    6. Abhijit Sen Gupta, 2010. "Robust monetary policies in small open economies," Oxford Economic Papers, Oxford University Press, vol. 62(2), pages 350-373, April.

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    More about this item

    Keywords

    Exchange rate pass-through; inflation targeting; interest rate inertia; monetary policy; small open economy;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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