Does the Central Bank of Peru respond to exchange rate movements? A Bayesian estimation of a New Keynesian DSGE model with FX interventions

Gabriel Rodríguez, Paul Castillo B. and Harumi Hasegawa

The North American Journal of Economics and Finance, 2023, vol. 68, issue C

Abstract: This paper assesses the role played by the exchange rate and FX intervention in setting monetary policy interest rates in Peru. We estimate a Taylor rule that includes inflation, output gap and the exchange rate using a New Keynesian DSGE model that follows closely Schmitt-Grohé and Uribe (2017). The model is extended to include an explicit sterilized FX intervention rule as in Faltermeier, Lama, and Medina (2017). The main empirical results show that the model that features a Taylor rule which does not respond to changes in the nominal exchange rate and considers an active use of FX interventions by the Central Bank of Peru clearly outperforms other model specifications in terms of the marginal log density. We also find that the coefficient associated with the response of the Taylor rule to inflation is close to 2 and the one associated with the output gap is greater than 1. Additionally, we find that FX interventions have become more responsive to exchange rate fluctuations during the IT period. Finally, the estimated IRFs show that FX interventions has contributed to reducing the volatility of GDP in response to productivity and terms of trade shocks in Peru.

Keywords: Small open economy; Taylor rule; Monetary policy rule; Exchange rate; Bayesian methodology; Peruvian economy; FX interventions; New Keynesian DSGE model (search for similar items in EconPapers)
JEL-codes: C22 C52 F41 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Does the Central Bank of Peru Respond to Exchange Rate Movements? A Bayesian Estimation of a New Keynesian DSGE Model with FX Interventions (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:68:y:2023:i:c:s1062940823000888

DOI: 10.1016/j.najef.2023.101965

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