The paper addresses whether or not the exchange rate or some other dimension of the external side of the economy should form an integral part of the monetary rule for a small open economy (SOE) in which the central bank faces data deficiencies. Under a number of information scenarios, the model’s simulations suggest that some reflection of the external environment facing the SOE—either the real exchange rate gap and/or the law of one price gap—is needed to improve monetary policy performance. When the money rule includes both interest rate smoothing and the real exchange rate (or law of one price gap), the relative welfare gain from their inclusion increases as the monetary authorities loses access to more current and reliable information.

Additional Metadata
Keywords New Keynesian small open economy model, exchange rate pass through, optimal simple money rules, stochastic general equilibrium model.
Publisher Department of Economics
Series Carleton Economic Papers (CEP)
Luo, Deming, & Ferris, J.S. (2008). Optimal Simple Monetary Policy Rules in a Small Open Economy with Exchange Rate Imperfections (No. CEP 08-03). Carleton Economic Papers (CEP). Department of Economics.