Seminarios

Presenta: Rodrigo Caputo (Ph.D. in Economics, University of Cambridge; Associate Professor, USACH; Research Associate, Center of Experimental Social Sciences (CESS), Oxford University-USACH).

Abstract: In a small economy, a monetary policy rule that reacts to domestic inflation implements the efficient allocation, as long as the natural rate of interest is known (Galí and Monacelli, 2005). In this case, a policy response to exchange rate is not only inefficient, but may lead to indeterminacy.  In this paper we show that, when the central bank is unable to observe the natural rate of interest, reacting to exchange rate movements is efficient. This reaction is proportional to the degree of openness and requires the central bank to respond also to domestic inflation and to the output gap. This type of reaction is in line with the evidence we find in four small open economies: Australia, Canada, New Zealand and the U.K.

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