Managing macroeconomic fluctuations with flexible exchange rate targeting

We show that a monetary policy rule uses the exchange rate to stabilize economy can outperform Taylor in managing macroeconomics fluctuations and achieving higher welfare. The differences between rules are driven by: (i) paths of nominal interest under each (ii) external habits consumption, which leads deviations from uncovered parity. These larger economies, very open, more exposed foreign shocks, or domestic goods highly substitutable.