The Mundellian trilemma and optimal monetary policy in a world of high capital mobility

This paper proposes that the Mundellian Trilemma remains valid despite the emergence of a world financial cycle. A clear distinction must be made between monetary policy independence and insulation of an open economy’s financial system. A flexible exchange rate allows an optimizing central bank to chart an independent course but does not insulate the domestic financial sector or broader economy from foreign monetary or financial shocks. The gains from a flexible exchange rate may be considerable and vary in accordance with the mandate of the central bank. The Mundellian Trilemma highlights the acute shortage of policy instruments and resulting tradeoffs among policy goals

The Real Exchange Rate in Taylor Rules: A Re-Assessment

Examining three flexible inflation targeting strategies, we find that a small concern for real exchange rate stability as a policy goal matters. First, it warrants the inclusion of the real exchange rate in Taylor rules and, second, it is sufficient to improve the performance of Taylor rules relative to optimal policy. Gains are substantial for domestic and REX inflation targets because a small weight on real exchange rate fluctuations makes optimal policy less aggressive. The gains under CPI inflation targeting are considerably lower

Does the fall in crude oil prices really affect the Malaysian ringgit?

The sudden drop in Malaysia exchange rate triggers a big question mark and of great concern to policy makers, investors, firms and Malaysian public at large. Theoretically, depreciation in any currency is not only caused by classical exchange rate determinant but various forces behind it. This study uses monetary approach to test the Malaysia exchange rate determinant. It also seeks to examine the correlation of Malaysia exchange rate with crude oil price. The sudden drop in the global crude oil price is one of the major factors of depreciation in the Malaysian Ringgit as claimed by some analysts. Using monthly data from January 2006 to March 2016 in the first regression, we adopted the monetary approach on exchange rate determinant without crude oil price variable and found that approximately 51% of the proposition of variation of the dependent variable is explained by the proposition of variation of the independent variables. When another explanatory variable, i.e. Brent Crude Oil prices is added to the model, the results indicated that this variable is very significant and caused R2 to increase tremendously to 91%. The model is further enhanced by remedying the multicollinearity problem and omitting one of the variables which has a high correlation with all other variables. In conclusion, the fall in crude oil prices does affect the Malaysia exchange rate heavily. The finding is useful to the policy makers to devise a policy in future which is less reliant on crude oil price

Nominal rigidity and some new evidence on the New Keynesian theory of the output-inflation tradeoff

This paper develops a series of tests to check whether the New Keynesian nominal rigidity hypothesis on the output-inflation tradeoff withstands new evidence. In so doing, I summarize and evaluate four different estimation methods that have been applied in the literature to address this hypothesis. Both cross-country and over-time variations in the output-inflation tradeoff are checked with the tests that differentiate the effects on the tradeoff that are attributable to nominal rigidity (the New Keynesian argument) from those ascribable to variance in nominal growth (the alternative new classical explanation). I find that in line with the New Keynesian hypothesis, nominal rigidity is an important determinant of the tradeoff. Given less rigid prices in high-inflation environments, changes in nominal demand are transmitted to quicker and larger movements in prices and lead to smaller fluctuations in the real economy. The tradeoff between output and inflation is hence smaller