Choosing a Monetary Policy Regime : E ® ects on the Traded and Non - Traded Sectors

The paper considers alternative monetary policy regimes within a calibrated macroeconomic model with a traded and a non-traded sector. Two classes of regimes are considered; in°ation targeting and exchange rate targeting. When the target variable is completely stabilized, both rules have poor stabilizing properties for all real variables nominal exchange rate targeting is even dynamically unstable. When the monetary authority places some weight on output stabilization in addition to the primary target variable, in°ation targeting outperforms exchange rate targeting in terms of output stability in both the traded and the non-traded sectors. ¤We have received valueable comments from Steinar Holden, Ragnar Nymoen, Dag ̄nn Rime, Asbj¿rn R¿dseth, Âystein Stephansen and Lars E.O. Svensson to earlier versions of this paper. We have also bene ̄ted from presenting this paper at seminars at the Bank of Norway; the Department of Economics, University of Oslo; the Norwegian School of Business Administration and at the EEA98 conference in Berlin. Throughout this paper we have used modi ̄ed computer programs that was originally constructed by Paul SÄoderlind and Warrick McKibbin. We are indebted to them all. Any remaining errors are our own. The views expressed are those of the authors, and not necessarily those of the Central Bank of Norway. yDepartment of Economics, University of Oslo, PO Box 1095 BLINDERN, 0317 OSLO, Norway zDepartment of International Economics, The Central Bank of Norway, PO Box 1179 Sentrum, 0107 OSLO, Norway.