Monetary Policy Rules and the Forward Discount Bias

Min-Yong Shin and Taehwan Yoo
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Min-Yong Shin: LG Economic Research Institute
Taehwan Yoo: Mokpo National University

Korean Economic Review, 2006, vol. 22, 299-317

Abstract: This is an attempt to explain forward discount bias in the foreign exchange market as influenced by monetary policy rules. A government response function to external shocks is combined with the monetary model for exchange rate determination, and the risk premium is assumed to follow a first order autoregressive process. The forward discount bias is more probable when the government is concerned with interest rate or money supply stability than when monetary policy focuses on the stabilization of foreign exchange rate or price level. These results are consistent with the experiences of ERM in the past-where forward discount bias is not found-and the survey results of Froot and Thaler (1990).

Keywords: Forward Discount Bias; Monetary Policy Rules; Interest Rate Smoothing; Exchange Rate Stabilization (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
Date: 2006
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