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Exchange rate determination under interest rate rules

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  • Benigno, Gianluca
  • Benigno, Pierpaolo

Abstract

We propose a theory of exchange rate determination under interest rate rules in a two-country model. We first show that simple interest rate feedback rules can determine a unique and stable equilibrium without any explicit reaction to the nominal exchange rate. We characterize how the behavior of the exchange rate and of the terms of trade depends in a critical way on the monetary regime chosen, though not necessarily on monetary shocks. We give a simple account of exchange rate volatility in terms of monetary policy rules, we provide an explanation of the relation between nominal exchange rate volatility and macroeconomic variability in terms of the monetary regime adopted by monetary authorities.

Suggested Citation

  • Benigno, Gianluca & Benigno, Pierpaolo, 2008. "Exchange rate determination under interest rate rules," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 971-993, October.
    • Handle: RePEc:eee:jimfin:v:27:y:2008:i:6:p:971-993
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    References listed on IDEAS

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