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GEMF

Grupo de Estudos Monetários e Financeiros

Estudos do GEMF, N.º 09 de 2007

  

Optimal Monetary Policy with a Regime-Switching Exchange Rate

in a Forward-Looking Model


Fernando Alexandre

NIPE and University of Minho

Pedro Bação
GEMF and Faculty of Economics of the University of Coimbra

John Driffill
Birkbeck College, University of London


Abstract:
We evaluate the macroeconomic performance of different monetary policy rules when there is exchange rate uncertainty. We do this in the context of a non-linear rational expectations model. The exchange rate is allowed to deviate from its fundamental value and the persistence of the deviation is modeled as a Markov switching process. Our results suggest that taking into account the switching nature of the economy is important only in extreme cases.

JEL Classification: E52, E58, F41.

Keywords: Exchange Rates, Monetary Policy, Markov Switching.

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