Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/212064 
Year of Publication: 
2007
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 6/2007
Publisher: 
Bank of Finland, Helsinki
Abstract: 
The aim of this paper is threefold: (i) to investigate if there is a unique rational expectations equilibrium (REE) in the small open economy in Gall and Monacelli (2005) that is augmented with technical trading in the foreign exchange market; (ii) to investigate if the unique REE is adaptively learnable in a recursive least squares sense; and (iii) to investigate if the unique and adaptively learnable REE is desirable in an inflation rate targeting regime in the sense that a low and not too variable CPI inflation rate in equilibrium is achieved. The monetary authority is using a Taylor rule when setting the nominal interest rate, and we investigate numerically the properties of the model developed. A main conclusion is that the monetary authority should increase (decrease) the interest rate when the CPI inflation rate increases (decreases) and when the currency gets stronger (weaker) to have a desirable rule that is robust with respect to the degree of technical trading in the foreign exchange market. Thus, the value of the currency is a better response variable than the output gap in the most desirable parametrizations of the interest rate rule.
Subjects: 
determinacy
foreign exchange
inflation rate targeting regime
interest rate rule
robust monetary policy
technical trading
JEL: 
E52
F31
Persistent Identifier of the first edition: 
ISBN: 
978-952-462-357-5
Document Type: 
Working Paper

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