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Does the Central Bank of Peru respond to exchange rate movements? A Bayesian estimation of a New Keynesian DSGE model with FX interventions

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  • Rodríguez, Gabriel
  • Castillo B., Paul
  • Hasegawa, Harumi

Abstract

This paper assesses the role played by the exchange rate and FX intervention in setting monetary policy interest rates in Peru. We estimate a Taylor rule that includes inflation, output gap and the exchange rate using a New Keynesian DSGE model that follows closely Schmitt-Grohé and Uribe (2017). The model is extended to include an explicit sterilized FX intervention rule as in Faltermeier, Lama, and Medina (2017). The main empirical results show that the model that features a Taylor rule which does not respond to changes in the nominal exchange rate and considers an active use of FX interventions by the Central Bank of Peru clearly outperforms other model specifications in terms of the marginal log density. We also find that the coefficient associated with the response of the Taylor rule to inflation is close to 2 and the one associated with the output gap is greater than 1. Additionally, we find that FX interventions have become more responsive to exchange rate fluctuations during the IT period. Finally, the estimated IRFs show that FX interventions has contributed to reducing the volatility of GDP in response to productivity and terms of trade shocks in Peru.

Suggested Citation

  • Rodríguez, Gabriel & Castillo B., Paul & Hasegawa, Harumi, 2023. "Does the Central Bank of Peru respond to exchange rate movements? A Bayesian estimation of a New Keynesian DSGE model with FX interventions," The North American Journal of Economics and Finance, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:ecofin:v:68:y:2023:i:c:s1062940823000888
    DOI: 10.1016/j.najef.2023.101965
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    1. Iskrev, Nikolay, 2010. "Local identification in DSGE models," Journal of Monetary Economics, Elsevier, vol. 57(2), pages 189-202, March.
    2. Carrasco, Alex & Florián Hoyle, David, 2020. "External shocks and FX intervention policy in emerging economies," Working Papers 2020-015, Banco Central de Reserva del Perú.
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    Cited by:

    1. Flavio Pérez Rojo & Gabriel Rodríguez, 2023. "Jane Haldimand Marcet: Impact of Monetary Policy Shocks in the Peruvian Economy Over Time," Documentos de Trabajo / Working Papers 2023-523, Departamento de Economía - Pontificia Universidad Católica del Perú.
    2. Donato Masciandaro, 2023. "How Elastic and Predictable Money Should Be: Flexible Monetary Policy Rules from the Great Moderation to the New Normal Times (1993-2023)," BAFFI CAREFIN Working Papers 23196, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    3. Yugang He & Zhuoqi Teng, 2024. "Navigating Uncharted Waters: The Transformation of the Bank of Korea’s Monetary Policy in Response to Global Economic Uncertainty," Mathematics, MDPI, vol. 12(11), pages 1-24, May.

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    More about this item

    Keywords

    Small open economy; Taylor rule; Monetary policy rule; Exchange rate; Bayesian methodology; Peruvian economy; FX interventions; New Keynesian DSGE model;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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