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Exploring the Role of the Real Exchange Rate in Australian Monetary Policy
Author(s) -
Dennis Richard
Publication year - 2003
Publication title -
economic record
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.365
H-Index - 42
eISSN - 1475-4932
pISSN - 0013-0249
DOI - 10.1111/1475-4932.00076
Subject(s) - exchange rate , economics , monetary policy , inflation (cosmology) , open economy , monetary economics , macroeconomics , interest rate , set (abstract data type) , inflation targeting , small open economy , real interest rate , computer science , physics , theoretical physics , programming language
An important issue in small open‐economies is whether policymakers should respond to exchange rate movements when they formulate monetary policy. Micro‐founded models tend to suggest that there is little to be gained from responding to exchange rate movements, and the literature has largely concluded that such a response is unnecessary, or even undesirable. This paper examines this issue using an estimated model of the Australian economy. In contrast to microfounded models, according to this model policymakers should allow for movements in the real exchange rate and the terms‐of‐trade when they set interest rates. Further, taking real exchange rate movements into account appears even more important with price level targeting than with inflation targeting.