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Trade Openness and Exchange Rate Management

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  • Parrado, Eric
  • Heresi, Rodrigo

Abstract

Singapore's unique monetary policy consists of a managed exchange rate framework that can be characterized as a Taylor-like reaction function with the nominal devaluation rate instead of the nominal interest rate as the main policy instrument. We build a small open economy New Keynesian model to estimate and characterize such a monetary rule from a welfare perspective. Welfare gains under an exchange rate rule (ERR) relative to the more standard interest rate-based Taylor rule (IRR) are unambiguously increasing in the degree of trade openness (defined as exports plus imports as a share of GDP). For Singapore, where trade openness is 280% of GDP, we estimate welfare gains of 1.48% of permanent consumption under an ERR. In a counterfactual thought experiment, we find that Chile, an established inflation-targeting economy using an IRR, would be better off under an ERR for any degree of openness above 100% (currently at 70%).

Suggested Citation

  • Parrado, Eric & Heresi, Rodrigo, 2023. "Trade Openness and Exchange Rate Management," IDB Publications (Working Papers) 13346, Inter-American Development Bank.
    • Handle: RePEc:idb:brikps:13346
    DOI: http://dx.doi.org/10.18235/0005490
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    References listed on IDEAS

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    1. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
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    More about this item

    Keywords

    Monetary policy; Exchange rate management; Open economy macroeconomics;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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