Exchange Rates and Monetary Policy in Emerging Market Economies

Philip R. Lane and Juanyi Xu Michael B. Devereux
Authors registered in the RePEc Author Service: Michael B. Devereux and Juanyi Xu ()

The Institute for International Integration Studies Discussion Paper Series from IIIS

Abstract: This paper compares alternative monetary policy rules in a model of an emerging market economy that experiences external shocks to world interest rates and the terms of trade. The model is a two-sector dynamic open economy, with endogenous capital accumulation and slow price adjustment. Two key factors are highlighted in examining the response of the economy to shocks, and in the assessment of the effectiveness of monetary rules.These are: a) balance-sheet related financial frictions in capital formation; and b) delayed pass-through of changes in exchange rates to imported goods prices. We find that, while financial frictions cause a magniFcation of real and financial volatility, they have no effect on the comparison or ranking of alternative monetary policies. But the degree of exchange rate pass-through is very important for the assessment of monetary rules. With high pass-through, there is a trade-off between between real stability (in output or employment) and inflation stability. Moreover, the best monetary policy rule in this case is to stabilise non-traded goods prices. But, with delayed pass-through, the same trade off between real stability and inflation stability disappears, and the best monetary policy rule is CPI price stability Classification-

Keywords: Monetary Policy; Exchange Rate Pass-through; Balance Sheet Constraints (search for similar items in EconPapers)
Date: 2005-04-20
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac and nep-mon
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Citations: View citations in EconPapers (16)

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Related works:
Journal Article: Exchange Rates and Monetary Policy in Emerging Market Economies (2006)
Working Paper: Exchange Rates and Monetary Policy in Emerging Market Economies (2001)
Working Paper: Exchange Rates and Monetary Policy in Emerging Market Economies (2001)
Working Paper: Exchange Rates and Monetary Policy in Emerging Market Economies (2001)
Working Paper: Exchange Rates and Monetary Policy in Emerging Market Economies (2000)
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