Exchange Rate Pass-through, Unemployment and Optimal Implementable Monetary Policy Rule for Emerging Economies

Chak Hung Jack Cheng

Global Economic Review, 2014, vol. 43, issue 3, 221-243

Abstract: This paper develops a small open economy model with nominal rigidities and search-matching frictions to study the implications of exchange rate pass-through for monetary policy in emerging countries. I find that, with complete exchange rate pass-through, the optimal policy rule features unemployment targeting as well as inflation targeting. However, the welfare gain from responding to unemployment fluctuations diminishes as the rate of exchange rate pass-through to import prices decreases. With low exchange rate pass-through, the optimal monetary policy is strict inflation targeting.

Date: 2014
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DOI: 10.1080/1226508X.2014.930979

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