Divergent relationships between exchange rate pass-through and policy rates across economies: An extension of the Taylor rule

Wei Ma, Renzhong Zhang, Liyan Han and Wei Li

Finance Research Letters, 2025, vol. 71, issue C

Abstract: Although central banks often prioritize exchange rate stability, its role is frequently overlooked in the monetary policy analysis and simple interest rate rules do not comprise exchange rate arguments even in small open economies. This study extends the traditional Taylor rule by incorporating exchange rate deviations to determine their influence on monetary policy conduct across various economies. Our findings reveal heterogeneous impacts of exchange rate deviations on policy rates. Specifically, exchange rates significantly influence monetary policy in economies with fixed exchange rate regimes, higher foreign reserve ratios and lower levels of financial development.

Keywords: Exchange rate; Taylor rule; Heterogeneity analysis; Monetary policy (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:71:y:2025:i:c:s1544612324014855

DOI: 10.1016/j.frl.2024.106456

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