EconPapers    
Economics at your fingertips  
 

When the Bubble Bursts: Monetary Policy Rules and Foreign Exchange Market Behavior

Nicoletta Batini and Edward Nelson

No 2000-01, Working Papers from University of Sydney, School of Economics

Abstract: We examine the effects of a “bubble” in the foreign exchange market, defined as an exogenous process that temporarily shifts the exchange rate away from the value implied by fundamentals. The bubble process is analogous to Bernanke and Gertler’s (1999) specification of an asset price bubble. We evaluate the performance of alternative simple monetary policy rules under both bubble and no-bubble scenarios and investigate whether policymakers should react to the deviation of the exchange rate from its steady-state value. The policy experiments employ a small-scale forward-looking structural model calibrated to UK data, which we previously used in Batini and Nelson (2000). For this model, which includes an uncovered interest parity condition, we find that the appropriate response to the exchange rate is captured by the expected inflation term, provided that the response coefficient and the inflation horizon are optimized. When uncovered interest parity is relaxed, there appears to be more merit in incorporating a separate exchange rate term in the monetary policy rule.

Date: 2000-10
References: Add references at CitEc
Citations: View citations in EconPapers (67)

Downloads: (external link)
http://econ-wpseries.com/2000/200001.pdf

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:syd:wpaper:2000-01

Access Statistics for this paper

More papers in Working Papers from University of Sydney, School of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Vanessa Holcombe (vanessa.holcombe@sydney.edu.au).

 
Page updated 2025-02-13
Handle: RePEc:syd:wpaper:2000-01