Taylor rules, fear of floating and the role of the exchange rate in monetary policy: a case of observational equivalence

Juan Paez-Farrell

Discussion Paper Series from Department of Economics, Loughborough University

Abstract: This paper considers the role of the exchange rate in monetary policy rules. It argues that much recent research aimed at determining the extent of concern for exchange rate stabilisation on the part of central banks is potentially flawed. If policy makers are subject to fear of floating – whereby they aim to stabilise exchange rates but without revealing this to the public – current estimated models cannot may provide insufficient information to determine policy objectives. In effect, several structural models may yield observationally equivalent interest rate rules. The paper uses two small open economy models to highlight this issue.

Keywords: Small open economies; monetary policy; exchange rates; Taylor rule; fear of floating. (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Date: 2012-06, Revised 2012-06
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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