Rational expectations, changing monetary policy rules, and real exchange rate dynamics

Shiu-Sheng Chen and Yu-Hsi Chou

Journal of Banking & Finance, 2012, vol. 36, issue 10, 2824-2836

Abstract: This paper reexamines the explanatory power of Taylor rule fundamentals for real exchange rate determination. We assume the agents know the time-varying parameters in central bank policy rules. The empirical results suggest that a monetary policy rule with regime switching is better able to explain the real Deutschemark/dollar exchange rate from 1976 to 1998 compared with a fixed-regime monetary policy rule. The findings show the importance of accounting for the expectation formation effect in changing policy rules as emphasized by the Lucas critique. Ignoring these effects can undermine the value of the rational expectations models.

Keywords: Rational expectations; Real exchange rate; Taylor rule (search for similar items in EconPapers)
JEL-codes: E5 F31 F41 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:10:p:2824-2836

DOI: 10.1016/j.jbankfin.2012.06.013

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