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Grupo de Estudos Monetários e Financeiros

Estudos do GEMF, N.º 06 de 2001


Inflation Targeting and Exchange Rate Co-ordination

Fernando Alexandre
Department of Economics, Birkbeck College and University of Minho

John Driffill
Department of Economics, Birkbeck College

Fabio Spagnolo

Department of Economics, Birkbeck College

In a linear rational expectations two-country model, using an aggregate demand-aggregate supply framework, we analyze the effects of the adoption of an inflation targeting regime on exchange rate volatility and the possible scope for policy coordination. This analysis is conducted using optimized interest rate policy rules within a calibrated model. Rules for interest rates that respond either to exchange rates or to portfolio shocks give improved performance and permit gains from international coordination. Optimized Taylor Rules perform relatively well.

JEL Classification: E17; E52; E61; F42.

Keywords: Inflation Targeting; Taylor Rule; Exchange Rate Coordination; Rational Expectations.

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