Optimal real exchange rate targeting: a stochastic analysis

Francesco Menoncin () and Marco Tronzano

Working Papers from University of Brescia, Department of Economics

Abstract: This paper extends the literature on real exchange rate targeting inside a stochastic optimization framework where the real exchange rate displays long run mean reversion while temporarily reflecting a “liquidity effect”. When real exchange rate volatility is constant, an active stabilization rule is welfare increasing with respect to non intervention only beyond a given volatility threshold. Moreover, the welfare gains are larger the lower is the degree of mean reversion. Under a stochastic volatility assumption, the policy maker’s intertemporal discount rate has instead a major influence, and real exchange rate targeting is welfare increasing only if the policymaker is sufficiently farsighted.

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Journal Article: Optimal Real Exchange Rate Targeting. A Stochastic Analysis (2007)
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