Money Supply Rules and Exchange Rate Dynamics

Juha Tervala ()

No 62, Discussion Papers from Aboa Centre for Economics

Abstract: This paper examines the implications of monetary policy rules for exchange rate dynamics. I extend a standard New Open Economy Macroeconomics model with the introduction of a simple money supply rule, whereby central banks change their monetary policy if output diverges from potential output or if inflation diverges from the target inflation. A key result is that, in the case of permanent technology and monetary shocks, the nominal exchange rate does not follow a random walk; instead, the exchange rate undershoots its long-run value. An undershooting of the exchange rate derives from the active monetary policy that both countries conduct.

Keywords: Monetary policy rules; open economy macroeconomics; exchange rate (search for similar items in EconPapers)
JEL-codes: E5 F3 F4 (search for similar items in EconPapers)
Pages: 30
Date: 2010-12
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac and nep-mon
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