“Leaning With the Wind”? An Open-Economy Example
Abstract:
This paper uses a forward-looking open-economy optimizing model to show that
the existence of an exchange rate channel in the Phillips Curve dramatically
alters the conduct of optimal monetary policy. The central bank’s optimal reaction
function can produce a “lean with the wind” response to IS and foreign output
shocks provided there are both a pronounced exchange rate channel and a high
degree of persistence in the disturbances. The existence of such an exchange
rate channel in the Phillips Curve generally leads to smaller fluctuations
in the policy instrument and all endogenous variables except the real output
gap.
JEL Classification Codes: E52, F41