Research Discussion Papers, Bank of Finland
Optimal monetary policy under heterogeneity in currency trade
Abstract: We embed an expectations-based optimal policy rule into a
DSGE model for a small open economy that is augmented with trend
extrapolation or chartism, which is a form of technical trading, in
currency trade to examine the prerequisites for monetary policy. We find
that a unique REE that is least-squares learnable is often the outcome when
there is a limited amount of trend extrapolation, but that a less flexible
inflation rate targeting may cause a multiplicity of REE. We also compute
impulse-response functions for key macroeconomic variables to study how the
economy returns to steady state after being hit by a shock.
Keywords: determinacy; DSGE model; least-squares learning; targeting rule; technical trading; monetary policy; (follow links to similar papers)
JEL-Codes: C62; E52; F31; F41; (follow links to similar papers)
28 pages, November 14, 2007
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