() and Daria Finocchiaro
Vasco Cúrdia: Princeton University, Postal: 001 Fisher Hall, Princeton, NJ 08544, USA,
Daria Finocchiaro: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden
Abstract: Using Bayesian methods, we estimate a small open economy model for Sweden. We explicitly account for a monetary regime change from an exchange rate target zone to flexible exchange rates with explicit inflation targeting. In each of these regimes, we analyze the behavior of the monetary authority and the relative contribution to the business cycle of structural shocks in detail. Our results can be summarized as follows. Monetary policy is mainly concerned with stabilizing the exchange rate in the target zone and with price stability in the inflation targeting regime. Expectations of realignment and the risk premium are the main sources of volatility in the target zone period. In the inflation targeting period, monetary shocks are important sources of volatility in the short run, but in the long run, labor supply and preference shocks become relatively more important. Foreign shocks are much more destabilizing under the target zone than under inflation targeting.
59 pages, October 1, 2005
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