Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/56253
Authors: 
Adolfson, Malin
Year of Publication: 
2001
Series/Report no.: 
SSE/EFI Working Paper Series in Economics and Finance 476
Abstract: 
The central bank's optimal reaction to foreign and domestic shocks is analyzed in an inflation targeting model allowing for incomplete exchange rate pass-through. Limited pass-through is incorporated through nominal rigidities in an aggregate supply-aggregate demand model derived from some microfoundations. Three main results are obtained. First, the results suggest that the interest rate response to foreign shocks is smaller when pass-through is low. Second, the inflation-output variability trade-off becomes more favourable as pass-through decreases. Third, lower pass-through, that is larger nominal rigidity, leads to higher exchange rate volatility. With exogenous nominal price stickiness, part of the required relative price adjustment is provided through larger movements in the endogenously determined exchange rate.
Subjects: 
Exchange rate pass-through
exchange rate volatility
inflation targeting
monetary policy
small open economy
JEL: 
E52
E58
F41
Document Type: 
Working Paper

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