Maintaining price stability under free-floating: a fearless way out of the corner?

Carsten Detken and Gaspar, Ví­tor

No 241, Working Paper Series from European Central Bank

Abstract: The behaviour of the exchange rate under a floating exchange rate regime for a small open economy with perfect capital mobility may appear like a managed float or even a firmer peg. We present a canonical new neo-classical synthesis open economy model where the central bank follows a strategy directed at maintaining price stability. It is shown that the behaviour of the exchange rate depends on the structure of the economy and on the nature of the relevant shocks. In the case of very open economies the exchange rate will look quasi-fixed in response to shocks stemming from the international capital markets. It is also shown that the joined endogeneity of the interest rate and the exchange rate has important implications for the empirical testing of uncovered interest rate parity. JEL Classification: E58, E63, F41

Keywords: flexible exchange rates; managed floating; price stability; small open economy; uncovered interest rate parity (search for similar items in EconPapers)
Date: 2003-07
Note: 229418
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2003241

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