Monetary Policy and Uncertainty in an Empirical Small Open Economy Model
Federal Reserve Bank of Chicago
Bruce J. Preston
Columbia University - Graduate School of Arts and Sciences - Department of Economics
March 14, 2008
FRB of Chicago Working Paper No. 2009-21
This paper explores optimal policy design in an estimated model of three small open economies: Australia, Canada and New Zealand. Within a class of generalized Taylor rules, we show that to stabilize a weighted objective of output, consumer price inflation and nominal interest variation optimal policy does not respond to the nominal exchange. This is despite the presence of local currency pricing and due, in large part, to observed exchange rate disconnect in these economies. Optimal policies that account for the uncertainty of model estimates, as captured by the parameters' posterior distrbution, similarly exhibit a lack of exchange rate response. In contrast to Brainard (1967), the presence of parameter uncertainty can lead to more or less aggressive policy responses, depending on the model at hand.
Number of Pages in PDF File: 62
Keywords: Open Economy Macroeconomics, Optimal Monetary Policy, Uncertainty, Bayesian Estimation DSGE Models
JEL Classification: E30, F41
Date posted: December 5, 2009
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