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Other stabilisation objectives within an inflation targeting regime: Some stochastic simulation experiments

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Abstract

We use the Reserve Bank of New Zealand's macroeconomic model (FPS) to look at the feasibility of using monetary policy to reduce variability in output, the exchange rate and interest rates while maintaining an inflation target. Our experiment suggests that policy could be altered to increase the stability of interest rates, the exchange rate, inflation, or output, relative to the base case reaction function in FPS, but such a policy would incur some cost in terms of the variability of the other variables. In particular, we find that greater exchange rate stability would have relatively large costs in terms of the stability of all three other variables, primarily because monetary policy that leans too dramatically against exchange rate disturbances can create significant real economy variability. Relative to West (2003), we find larger costs of operating monetary policy to achieve exchange rate stabilisation. We attribute this finding to the relatively inertial inflation expectation process in FPS.

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  • James Twaddle & David Hargreaves & Tim Hampton, 2006. "Other stabilisation objectives within an inflation targeting regime: Some stochastic simulation experiments," Reserve Bank of New Zealand Discussion Paper Series DP2006/04, Reserve Bank of New Zealand.
    • Handle: RePEc:nzb:nzbdps:2006/04
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    Cited by:

    1. Dominick Stephens, 2006. "Should monetary policy attempt to reduce exchange rate volatility in New Zealand?," Reserve Bank of New Zealand Discussion Paper Series DP2006/05, Reserve Bank of New Zealand.
    2. Willy Chetwin & Tim Ng & Daan Steenkamp, 2013. "New Zealand’s short- and medium-term real exchange rate volatility: drivers and policy implications," Reserve Bank of New Zealand Analytical Notes series AN2013/03, Reserve Bank of New Zealand.

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    More about this item

    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
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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