Optimal exchange rate policy in a low interest rate environment

Robert Pavasuthipaisit ()

MPRA Paper from University Library of Munich, Germany

Abstract: This paper examines optimal exchange policy when nominal interest rates are unusually low, as experienced by several Asian economies and Japan since July 2006. The paper finds that in such environments, it is optimal to create a nominal depreciation to offset contractionary disturbances. However, the limited scope of monetary policy easing may compromise the ability of the central bank to create a nominal depreciation especially if the central bank makes decisions on monetary policy making on a discretionary basis. In order to successfully create a nominal depreciation, the central bank needs to rely on the expectations channel, by making a credible promise to keep its currency weak going forward. Finally, trade liberalization, by enhancing the role of the exchange rate channel on the transmission mechanism, may allow the central bank to achieve lower average inflation.

Keywords: Zero lower bound; liquidity trap; exchange rate policy; open-economy macroeconomics (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Date: 2007-05
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac, nep-mon and nep-sea
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:3596

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