How Costly is Exchange Rate Stabilisation for an Inflation Targeter? The Case of Australia

Mark Crosby, Timothy Kam and Kirdan Lees

The Economic Record, 2008, vol. 84, issue 266, 354-365

Abstract: This paper quantifies the costs of mitigating exchange rate volatility within the context of a flexible inflation targeting central bank. Within a standard linear‐quadratic formulation of inflation targeting, we append a term that penalises deviations in the exchange rate to the central bank's loss function. For a simple forward‐looking new‐Keynesian model, we show that the central bank can reduce volatility in the exchange rate relatively costlessly by aggressively responding to the real exchange rate. However, when we append correlated shocks to better match summary statistics of the Australian data, we find that the costs associated with reducing exchange rate volatility are larger: output volatility increases substantially. Finally, we apply our method to a variant of a small backward‐looking new‐Keynesian model of the Australian economy. Under this model, large increases in inflation and output volatility accrue if the central bank attempts to mitigate exchange rate volatility.

Date: 2008
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://doi.org/10.1111/j.1475-4932.2008.00496.x

Related works:
Working Paper: How costly is exchange rate stabilisation for an inflation targeter? The case of Australia (2006)
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:bla:ecorec:v:84:y:2008:i:266:p:354-365

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0013-0249

Access Statistics for this article

The Economic Record is currently edited by Paul Miller, Glenn Otto and Martin Richardson

More articles in The Economic Record from The Economic Society of Australia Contact information at EDIRC.
Bibliographic data for series maintained by Wiley Content Delivery ().