Research Discussion Papers, Bank of Finland
No 1/1998:
Monetary Policy in a Bipolar International Monetary System
Sinimaaria Ranki ()
Abstract: The study deals with the international transmission of
economic shocks, their consequences for exchange rates and the
reconciliation of exchange rate management with monetary policy. The
theoretical part of the study consists of a mainstream model of two large,
interdependent economies with special emphasis on the effects of various
shocks on the inflation rate and exchange rate. The empirical application
uses US and German data to shed light on the exchange rate implications of
the choices faced by European and US monetary policymakers. The results
suggest that the inflation rate is dominated by domestic supply shocks in
both economies studied. When such shocks raise the domestic price level,
the currency also depreciates. This aspect of the results means that, from
a single-country perspective, monetary policy measures aimed at stabilizing
the price level can be compatible with stabilization of the exchange rate
as well. However, from the viewpoint of the other country, a conflict
emerges between exchange rate and price stability. This difference causes a
dilemma in international monetary coordination. Allowing that exchange rate
considerations affect monetary policy, the situation is further complicated
by the fact that exchange rate volatility seems to be for the most part
independent of the economic fundamentals included in the study.
Keywords: euro; monetary policy; exchange rate; shock transmission; (follow links to similar papers)
49 pages, March 15, 1998
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