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

Shiu Sheng Chen, Yu Hsi Chou

Research output: Contribution to journalArticle

2 Citations (Scopus)

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.

Original languageEnglish
Pages (from-to)2824-2836
Number of pages13
JournalJournal of Banking and Finance
Volume36
Issue number10
DOIs
Publication statusPublished - 2012 Oct 1

Keywords

  • Rational expectations
  • Real exchange rate
  • Taylor rule

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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