Trade Openness and Exchange Rate Management

Eric Parrado () and Rodrigo Heresi

No 13346, IDB Publications (Working Papers) from Inter-American Development Bank

Abstract: Singapore's unique monetary policy consists of a managed exchange rate framework that can be characterized as a Taylor-like reaction function with the nominal devaluation rate instead of the nominal interest rate as the main policy instrument. We build a small open economy New Keynesian model to estimate and characterize such a monetary rule from a welfare perspective. Welfare gains under an exchange rate rule (ERR) relative to the more standard interest rate-based Taylor rule (IRR) are unambiguously increasing in the degree of trade openness (defined as exports plus imports as a share of GDP). For Singapore, where trade openness is 280% of GDP, we estimate welfare gains of 1.48% of permanent consumption under an ERR. In a counterfactual thought experiment, we find that Chile, an established inflation-targeting economy using an IRR, would be better off under an ERR for any degree of openness above 100% (currently at 70%).

Keywords: Monetary policy; Exchange rate management; Open economy macroeconomics (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Date: 2023-12
New Economics Papers: this item is included in nep-cba, nep-dge, nep-int, nep-mon, nep-opm and nep-sea
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Persistent link: https://EconPapers.repec.org/RePEc:idb:brikps:13346

DOI: 10.18235/0005490

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