Working Paper: NBER ID: w8681
Authors: Andrew Atkeson; Patrick Kehoe
Abstract: Is the exchange rate or the money growth rate the better instrument of monetary policy? A common argument is that the exchange rate has a natural advantage because it is more transparent: it is easier for the public to monitor than the money growth rate. We formalize this argument in a simple model in which the government chooses which instrument it will use to target inflation. We find that when the government cannot commit to its policies, the greater transparency of the exchange rate makes it easier to provide the government with incentives to pursue good policies. Hence, transparency gives the exchange rate a natural advantage over the money growth rate as the monetary policy instrument.
Keywords: Monetary Policy; Exchange Rate; Money Growth Rate; Transparency
JEL Codes: E5; E52; E61; F33; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Choice of monetary policy instrument (exchange rate) (E52) | Transparency of monetary policy (E52) |
| Transparency of the exchange rate (F31) | Public monitoring of government actions (H83) |
| Public monitoring of government actions (H83) | Government's actions regarding inflation (E64) |
| Government's actions regarding inflation (E64) | Stability of inflation outcomes (E31) |
| Choice of monetary policy instrument (money growth rate) (E52) | Less transparency than exchange rate (F31) |
| Less transparency than exchange rate (F31) | Less precise responses to deviations (C62) |
| Less precise responses to deviations (C62) | Harder to deter surprise inflation (E31) |
| Exchange rate regime preferred (F33) | Lower average inflation rates when government cannot commit (E31) |