Real-Exchange-Rate-Adjusted Inflation Targeting in an Open Economy: Some Analytical Results

Richard T. Froyen and Alfred Guender

Working Papers in Economics from University of Canterbury, Department of Economics and Finance

Abstract: Under optimal policy from a timeless perspective, a central bank targeting an inflation measure which is adjusted for changes in the real exchange rate (REX inflation) has the ability to stabilize the output gap and inflation against demand disturbances in an open economy. This distinct advantage is lost if a central bank follows a Taylor-type rule. The bank has an incentive to add the real exchange rate to the Taylor rule because it duplicates the performance of the optimal policy for portfolio shocks. The Taylor-type rule becomes a Monetary Conditions Index (MCI) that outperforms Taylor-type rules which accord no weight at all or a higher weight to the real exchange rate. In the current environment of concern about sudden increases in U.S. interest rates, the properly designed MCI would have a considerable advantage.

Keywords: REX Inflation; Optimal Policy; Taylor-Type Rules; MCI; Openness; Portfolio Shocks (search for similar items in EconPapers)
JEL-codes: E3 E5 F5 (search for similar items in EconPapers)
Pages: 12 pages
Date: 2015-06-19
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://repec.canterbury.ac.nz/cbt/econwp/1514.pdf (application/pdf)

Related works:
Journal Article: Real-Exchange-Rate-Adjusted Inflation Targeting in an Open Economy: Some Analytical Results (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cbt:econwp:15/14

Access Statistics for this paper

More papers in Working Papers in Economics from University of Canterbury, Department of Economics and Finance Private Bag 4800, Christchurch, New Zealand. Contact information at EDIRC.
Bibliographic data for series maintained by Albert Yee ().