Creator: Atkeson, Andrew and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 297 Abstract:
Monetary policy instruments differ in tightness—how closely they are linked to inflation—and transparency—how easily they can be monitored. Tightness is always desirable in a monetary policy instrument; when is transparency? When a government cannot commit to follow a given policy. We apply this argument to a classic question: Is the exchange rate or the money growth rate the better monetary policy instrument? We show that if the instruments are equally tight and a government cannot commit to a policy, then the exchange rate’s greater transparency gives it an advantage as a monetary policy instrument.
Keyword: Nominal Anchor, Monetary Instrument, Exchange Rate Regime, Time Consistency, and Fixed Exchange Rates Subject (JEL): F33 - International Monetary Arrangements and Institutions, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, F41 - Open Economy Macroeconomics, and E52 - Monetary Policy