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Managing Macroeconomic Fluctuations with Flexible Exchange Rate Targeting

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  • Jonas Heipertz
  • Ilian Mihov
  • Ana Maria Santacreu

Abstract

We show that a monetary policy rule that uses the exchange rate to stabilize the economy can outperform a Taylor rule in managing macroeconomics fluctuations and in achieving higher welfare. The differences between the rules are driven by: (i) the paths of the nominal exchange rate and the interest rate under each rule and (ii) external habits in consumption, which leads to deviations from uncovered interest parity. These differences are larger in economies, which are very open, which are more exposed to foreign shocks, or in which domestic and foreign goods are highly substitutable.

Suggested Citation

  • Jonas Heipertz & Ilian Mihov & Ana Maria Santacreu, 2017. "Managing Macroeconomic Fluctuations with Flexible Exchange Rate Targeting," Working Papers 2017-028, Federal Reserve Bank of St. Louis, revised 16 Jan 2022.
    • Handle: RePEc:fip:fedlwp:2017-028
    DOI: 10.20955/wp.2017.028
    Note: Publisher DOI: https://doi.org/10.1016/j.jedc.2022.104311
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    1. Two papers on exchange rate policy
      by Christian Zimmermann in NEP-DGE blog on 2017-12-14 23:34:59

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    2. Parrado, Eric, 2023. "An Exchange Rate Policy Rule," IDB Publications (Working Papers) 13347, Inter-American Development Bank.

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    More about this item

    Keywords

    Monetary Policy Rules; Exchange Rate Management; Time-Varying Risk Premium; Welfare;
    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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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