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Title: |
On Discretion versus Commitment and the Role of the Direct Exchange Rate Channel in a Forward-Looking Open Economy Model |
| Author: |
Alfred V. Guender |
| Author
Affiliation: |
University of Canterbury, New Zealand |
| Source: |
International Economic Journal, September 2005, v. 19, no. 3, pp. 355-377 |
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Publication Date: |
September 2005 |
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Abstract: |
This paper compares optimal monetary policy under discretion and commitment in an economy where the direct exchange rate channel is operative. The stabilization bias under discretion is shown to be weaker in an open economy relative to a closed economy. In an open economy, a "less conservative central banker", one that attaches a smaller weight to the variance of inflation in the loss function, can be appointed to replicate the behavior of real output that eventuates under commitment. Evaluating the social loss function under discretion and commitment, we find that the existence of a direct exchange rate channel in the Phillips Curve mitigates the pronounced differences between the two strategies in case of high persistence in the stochastic shocks. |
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