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Short-run independence of monetary policy under pegged exchange rates and effects of money on exchange rates and interest rates

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  • Lee E. Ohanian
  • Alan C. Stockman

Abstract

Economists generally assert that countries sacrifice monetary independence when they peg their exchange rates. At the same time, central bankers frequently assert that pegging an exchange rate does not eliminate the independence of monetary policy. This paper examines the effects of money-supply changes on exchange rates, interest rates, and production in an optimizing two-country model in which some sectors of the economy have predetermined nominal prices in the short run and other sectors have flexible prices. Money-supply shocks have liquidity effects both within and across countries and induce a cross-country real-interest differential. The model predicts that liquidity effects are highly non-linear and are not likely to be captured well empirically by linear models, particularly those involving only a single country. The most striking implication of the model is that countries have a degree of short-run independence of monetary policy even under pegged exchange rates.
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Suggested Citation

  • Lee E. Ohanian & Alan C. Stockman, 1997. "Short-run independence of monetary policy under pegged exchange rates and effects of money on exchange rates and interest rates," Proceedings, Federal Reserve Bank of Cleveland, pages 783-814.
    • Handle: RePEc:fip:fedcpr:y:1997:p:783-814
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    References listed on IDEAS

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    More about this item

    Keywords

    Monetary policy; Money supply;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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