Jonas Heipertz, Ilian Mihov, Ana Maria Santacreu
We show that a monetary policy rule that uses the exchange rate to stabilize the economy can outperform a Taylor rule in managing macroeconomics fluctuations and in achieving higher welfare. The differences between the rules are driven by: (i) the paths of the nominal exchange rate and the interest rate under each rule and (ii) external habits in consumption, which leads to deviations from uncovered interest parity. These differences are larger in economies, which are very open, which are more exposed to foreign shocks, or in which domestic and foreign goods are highly substitutable. © 2022 Elsevier B.V.
Columbia University, Department of Economics, 3022 Broadway New York, 10027, NY, United States; INSEAD, CEPR and ABFER, Economics Department, 1 Ayer Rajah Avenue Singapore, 138678, Singapore; Federal Reserve Bank of St. Louis, Research Division, 1 Federal Reserve Bank Plaza, St. Louis, 63102, MO, United States
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