CPI Inflation Targeting and the UIP Puzzle: An Appraisal of Instrument and Target Rules (2011)
Type of ContentDiscussion / Working Papers
PublisherCollege of Business and Economics
University of Canterbury. Department of Economics and Finance
Employing an optimizing framework, this paper shows that a target rule dominates a simple instrument rule when the focus of monetary policy is on CPI inflation. The target rule approach produces a systematic relationship between the current CPI inflation rate and the lagged policy instrument that renders the former immune to the stochastic risk premium. No matter how policy parameters are set, the optimal simple instrument rule cannot replicate the superior stabilization results achieved by the target rule approach. The optimal simple instrument rule also fails to account for the UIP puzzle. In contrast, the target rule approach can motivate the widely reported phenomenon whereby high interest rate currencies tend to appreciate. In fact the degree of openness and the central bank’s relative aversion to CPI inflation variability determine the sensitivity of observed changes in the nominal exchange rate to the lagged interest rate differential.
CitationGuender, A.V. (2011) CPI Inflation Targeting and the UIP Puzzle: An Appraisal of Instrument and Target Rules. Department of Economics and Finance. 28pp..
This citation is automatically generated and may be unreliable. Use as a guide only.
KeywordsCPI Inflation Targeting; UIP Puzzle; Instrument Rule; Target Rule; Optimal Monetary Policy
ANZSRC Fields of Research38 - Economics::3801 - Applied economics::380112 - Macroeconomics (incl. monetary and fiscal theory)
15 - Commerce, Management, Tourism and Services::1502 - Banking, Finance and Investment
Showing items related by title, author, creator and subject.
Froyen R; Guender, Alfred (2022)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 ...
Froyen RT; Guender, Alfred (Elsevier BV, 2021)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 ...
International Evidence on the Role of Monetary Policy in the Uncovered Interest Rate Parity Puzzle Guender, A.V. (University of Canterbury. Department of Economics and Finance, 2015)CPI inflation targeting necessitates a flexible exchange rate regime. This paper embeds an endogenous target rule into a simple open economy macro model to explain the UIP puzzle. The model predicts that the change in the ...