Rationale behind the responses of monetary policy to the real exchange rate in small open economies

Carlos García and Wildo Gonzalez P. ()

ILADES-UAH Working Papers from Universidad Alberto Hurtado/School of Economics and Business

Abstract: We estimate how monetary policy works in small open economies. To do so, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of small open economies (including Australia, Chile, Colombia, Peru and New Zealand) is rather similar to that observed in developed countries. Nevertheless, our results also indicate that there are strong differences due to shocks from the international financial markets (risk premium shocks, mainly) that explain mostly the variability of the real exchange rate, which has important reallocation effects in the short run. In addition, we find that in practice central banks do not face any trade-off responding to these shocks through changes in the interest rate. This result is consistent with the fact that in each country under study, the exchange rate must be included in the policy reaction function.

Keywords: small open economy models; monetary policy rules; exchange rates; Bayesian econometrics (search for similar items in EconPapers)
JEL-codes: C32 E52 F41 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2009-12
New Economics Papers: this item is included in nep-cba, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:ila:ilades:inv228

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