Robust Taylor rules in an open economy with heterogeneous expectations and least squares learnig

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Title: Robust Taylor rules in an open economy with heterogeneous expectations and least squares learnig
ISBN: 978-952-462-356-8
Author: Bask, Mikael ; Selander, Carina
Organization: Suomen Pankki
Series: Bank of Finland Research Discussion Papers
ISSN: 1456-6184
Series year: 2007
Series number: 6/2007
Year of publication: 2007
Publication date: 8.2.2007
Published in: Published in International Economics and Economic Policy, Volume 6, Number 3, October 2009: 283-313
DOI: 10.1007/s11079-008-9095-3
Pages: 54 s.
Keywords: rahapolitiikka; keskuspankit; rationaaliset odotukset; korot; säännöt; tavoitteet; oppiminen; valuuttakauppa; inflaatio; kuluttajahinnat;
JEL: E52; F31
Abstract: The aim of this paper is threefold: (i) to investigate if there is a unique rational expectations equilibrium (REE) in the small open economy in Gall and Monacelli (2005) that is augmented with technical trading in the foreign exchange market; (ii) to investigate if the unique REE is adaptively learnable in a recursive least squares sense; and (iii) to investigate if the unique and adaptively learnable REE is desirable in an inflation rate targeting regime in the sense that a low and not too variable CPI inflation rate in equilibrium is achieved. The monetary authority is using a Taylor rule when setting the nominal interest rate, and we investigate numerically the properties of the model developed. A main conclusion is that the monetary authority should increase (decrease) the interest rate when the CPI inflation rate increases (decreases) and when the currency gets stronger (weaker) to have a desirable rule that is robust with respect to the degree of technical trading in the foreign exchange market. Thus, the value of the currency is a better response variable than the output gap in the most desirable parametrizations of the interest rate rule. JEL classification numbers: E52, F31 Key words: determinacy, foreign exchange, inflation rate targeting regime, interest rate rule, robust monetary policy, technical trading
Note: Liittyy International economics and economic policy 2009 ; 6 ; 3.

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