SSE/EFI Working Paper Series in Economics and Finance
Optimal Monetary Policy Delegation under Incomplete Exchange Rate Pass-Through
Abstract: The central bank’s optimal objective function is analyzed
in a small open economy model allowing for incomplete exchange rate
pass-through. The results indicate that social welfare can only be
marginally improved by including an explicit exchange-rate term in the
delegated objective function, irrespective of the degree of pass-through.
An implicit response to the exchange rate, through Consumer Price Index
(CPI) inflation targeting is, however, beneficial. Welfare can, moreover,
be enhanced by appointing a central banker with a greater preference for
interest rate smoothing than that of the society, as a result of surpassing
some of the stabilization bias arising under a discretionary policy.
Consequently, there are welfare gains from monetary policy inertia. The
optimal degree of interest rate smoothing is increasing in the degree of
Keywords: Exchange rate pass-through; inflation targeting; interest rate inertia; monetary policy; small open economy; (follow links to similar papers)
JEL-Codes: E52; E58; F41; (follow links to similar papers)
37 pages, October 31, 2001
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