Time Inconsistency and the Exchange Rate Channel of Monetary Policy

Kai Leitemo, Øistein Roisland and Ragnar Torvik

Scandinavian Journal of Economics, 2002, vol. 104, issue 3, 391-397

Abstract: This paper analyses time–inconsistency problems related to the exchange rate channel of monetary policy. Within a simple open–economy macroeconomic model, where the exchange rate is the only forward–looking variable, we show that a difference emerges between optimal policy under discretion and under commitment. Moreover, the nature of the time–inconsistency problem resembles that resulting from standard New Keynesian models: when cost–push shocks occur, the exchange rate channel gives rise to excessive output stabilisation and insufficient inertia in monetary policy under a discretionary policy. JEL classification: E42; E52; E61

Date: 2002
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