Research Discussion Papers, Bank of Finland
Instrument rules in monetary policy under heterogeneity in currency trade
Abstract: We embed different instrument rules into a New Keynesian
model for a small open economy that is augmented with technical trading in
currency trade to examine the prerequisites for monetary policy.
Specifically, this paper focuses on conditions for a determinate,
least-squares learnable rational expectations equilibrium (REE). Under an
interest rate rule with only contemporaneous macroeconomic data, the
intensity of technical trading or trend-seeking in currency trade does not
affect these conditions, except in the case of an extensive use of
trend-seeking. On the other hand, if the central bank uses only
forward-looking information in its interest rate rule, a determinate and
learnable REE is a less likely outcome when trend-seeking in currency trade
becomes more popular. The interest rate rule followed by the central bank
in the model incorporates interest rate smoothing.
Keywords: determinacy; DSGE model; interest rate rule; least-squares learning; technical trading; (follow links to similar papers)
JEL-Codes: C62; E52; F31; F41; (follow links to similar papers)
29 pages, November 20, 2007
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