Monetary Policy Under an Exchange Rate Anchor
48 Pages Posted: 30 Oct 2020
Date Written: September 2020
This paper argues that there is scope for monetary policy under an exchange rate anchor, and discusses the related monetary policy design and implementation. It shows that the exchange rate can be used as the main monetary policy instrument while the policy rate can target the exchange rate. An exchange rate anchor is compatible with an inflation objective, provided fiscal dominance is not an issue, monetary conditions are supportive of the peg, and the level of international reserves is adequate. The paper argues that, while an exchange rate anchor is more prone to policy inconsistencies, there is ample scope for strengthening monetary policy design and implementation under soft pegs. In that context, the principles of dichotomy and interest rate parity are critical.
Keywords: Exchange rates, Exchange rate arrangements, Exchange rate anchor, Central bank policy rate, Banking, WP, tag0, exchange rate, interest rate, monetary policy, graphic tag0
JEL Classification: E61, F31, F32, E52, E43, G21
Suggested Citation: Suggested Citation