SSE/EFI Working Paper Series in Economics and Finance
No 476:
Monetary Policy with Incomplete Exchange Rate Pass-Through
Malin Adolfson ()
Abstract: The central bank’s optimal reaction to foreign and
domestic shocks is analyzed in an inflation targeting model allowing for
incomplete exchange rate pass-through. Limited pass-through is incorporated
through nominal rigidities in an aggregate supply-aggregate demand model
derived from some microfoundations. Three main results are obtained. First,
the results suggest that the interest rate response to foreign shocks is
smaller when pass-through is low. Second, the inflation-output variability
trade-off becomes more favourable as pass-through decreases. Third, lower
pass-through, that is larger nominal rigidity, leads to higher exchange
rate volatility. With exogenous nominal price stickiness, part of the
required relative price adjustment is provided through larger movements in
the endogenously determined exchange rate.
Keywords: Exchange rate pass-through; exchange rate volatility; inflation targeting; monetary policy; small open economy; (follow links to similar papers)
JEL-Codes: E52; E58; F41; (follow links to similar papers)
50 pages, October 31, 2001
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