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Monetary policy in oil exporting countries with fixed exchange rate and open capital account: expectations matter

Omar Chafik ()

MPRA Paper from University Library of Munich, Germany

Abstract: Nominal interest rate is generally assumed to follow an UIP condition when the exchange rate is fixed, and the capital account is opened. Consequently, domestic interest rate is determined by foreign rates and the risk premium. This paper shows that for an oil exporting country like UAE, adjusting nominal interest rate only to foreign rate could be economically inconsistent. In fact, what really matters with exchange rate is expectations, and for an oil exporter country like UAE these expectations are significantly impacted by oil prices. By incorporating a market-expected exchange rate mechanism in a semi-structural New Keynesian Model, this paper highlights the importance of this mechanism and provides a consistent analytical framework.

Keywords: Monetary policy; exchange rate; New Keynesian Model; UIP condition; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: C11 E3 E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-opm
Date: 2019-03
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