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Uncertain Potential Output and Simple Rules in Small Open Economy

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  • Guido Traficante

    (Università Europea di Roma)

Abstract

This paper analyzes the implications of incomplete information for the conduct of monetary policy in small-open economy. I use a standard theoretical DSGE model to evaluate the performance of simple rules, including the exchange rate peg. Incomplete information is modeled assuming that the central bank and the private sector observe domestic inflation and output with a measurement error, while they do not observe potential output. I show that not reacting to the exchange rate yields better outcomes in terms of a standard loss function. For the case of complete information and incomplete information, I quantify for which parameter configuration a Taylor rule reacting to both the exchange rate and the domestic inflation rate yields a higher loss than the fixed exchange rate regime.

Suggested Citation

  • Guido Traficante, 2017. "Uncertain Potential Output and Simple Rules in Small Open Economy," Computational Economics, Springer;Society for Computational Economics, vol. 50(3), pages 517-531, October.
    • Handle: RePEc:kap:compec:v:50:y:2017:i:3:d:10.1007_s10614-016-9601-4
    DOI: 10.1007/s10614-016-9601-4
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    Cited by:

    1. Guido Traficante, 2021. "Uncertain Potential Output: Implications for Monetary Policy in a Small Open Economy," Open Economies Review, Springer, vol. 32(5), pages 955-973, November.

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    More about this item

    Keywords

    Small open economy; Exchange rate regime; Monetary policy rules; Uncertainty;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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