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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

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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