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Taylor rules, fear of floating and the role of the exchange rate in monetary policy: a case of observational equivalence

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  • Juan Paez-Farrell

    (School of Business and Economics, Loughborough University, UK)

Abstract

This paper considers the role of the exchange rate in monetary policy rules. It argues that much recent research aimed at determining the extent of concern for exchange rate stabilisation on the part of central banks is potentially flawed. If policy makers are subject to fear of floating – whereby they aim to stabilise exchange rates but without revealing this to the public – current estimated models cannot may provide insufficient information to determine policy objectives. In effect, several structural models may yield observationally equivalent interest rate rules. The paper uses two small open economy models to highlight this issue.

Suggested Citation

  • Juan Paez-Farrell, 2012. "Taylor rules, fear of floating and the role of the exchange rate in monetary policy: a case of observational equivalence," Discussion Paper Series 2012_07, Department of Economics, Loughborough University, revised Jun 2012.
    • Handle: RePEc:lbo:lbowps:2012_07
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    File URL: http://www.lboro.ac.uk/departments/sbe/RePEc/lbo/lbowps/JPF_WP2012_07.pdf
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    References listed on IDEAS

    as
    1. McCallum, Bennett T & Nelson, Edward, 2000. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 16(4), pages 74-91, Winter.
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    6. Lubik, Thomas A. & Schorfheide, Frank, 2007. "Do central banks respond to exchange rate movements? A structural investigation," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1069-1087, May.
    7. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318, National Bureau of Economic Research, Inc.
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    More about this item

    Keywords

    Small open economies; monetary policy; exchange rates; Taylor rule; fear of floating.;
    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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