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EXCHANGE RATE STABILISATION, LEARNING AND THE TAYLOR PRINCIPLE

Peter Spahn ()

Australian Economic Papers, 2007, vol. 46, issue 2, 136-151

Abstract: The paper explores whether central banks can keep their interest rates independent from given foreign rates, and to what extent interest policies designed to stabilise nominal exchange rate changes can be applied instead of, or in addition to, the traditional interest rate response to inflation gaps. This modification of a Taylor Rule is analysed in a simple macro model with some New Keynesian features. Information is imperfect; agents cannot build rational expectations but try to learn 'true' market relations. Results show that the Taylor Principle can be generalised in an open economy with flexible exchange rates. Copyright 2007 The Authors Journal compilation 2007 Blackwell Publishing Ltd/University of Adelaide and Flinders University .

Date: 2007
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