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tual exchange rate policy implemented by the policy authority in period t, the expectation change,, must be held constant when exchange market pressure is imputed. With the independent of and held constant, the model-consistent elasticity obtained on the bases of Eq. (2.22) is . The measure of exchange market pressure implied by the model presented as below:

Eq. (2.22)

where . Because varies with the model specification, calculated values of exchange market pressure will not, in general, be model independent.

The index of exchange market intervention that measures the intervention activity of the policy authority in terms of the proportion of exchange market pressure relieved by exchange market intervention. When the policy authority engages only in direct exchange market intervention, the intervention index,, is defined as:

Eq. (2.23)

When a policy authority is known to use direct as well as indirect intervention, Eq. (2.23) must be modified in order to capture the impact of the change in domestic credit on the exchange rate.

2.4 INFLATION TARGETING AND OPTIMAL CONTROL THEORY

Inflation targeting is now a new gold standard for central banks. The regime is believed to perform better than, for instance, the alternative of controlling money for clamping down on inflation by giving monetary policy more transparency and thus credibility. Instead of trying to meet monetary targets, central banks use their own money to determine short-term interest rates and thus control inflation directly. Tethering inflationary expectations is vital under this regime. If agents believe that the inflation target will be hit, then inflationary shocks will be absorbed. (Veloso, Thiago, Meurer, Roberto & Da Silva, 2007)

The optimal control model is built on the Taylor rule model of Eichengreen. (Eichengreen, 2002) Eichengreen’s model tracks the major features of open emerging markets, and can be described by equation Eq. (2.24) - Eq. (2.26).

Eq. (2.24)

Eq. (2.25)

Eq. (2.26)

where and are inflation rate and inflation rate target respectively. is output deviation from its natural level, is the nominal exchange rate, , , and are domestic, foreign and neutral interest rate respectively, and ? are disturbance terms, and v is a financial disturbance.

Eq. (2.24) id the expectational Phillips curve, and Eq. (2.25) is aggregate demand for an open economy. The interest rate impact on output is captured by parameter . Eq. (2.26) is uncovered interest parity, where is assumed to be constant when deriving the Taylor rule.

High degree of pass through is tracked by both a big and a small because these values mean that exchange rate depreciation causes rapid increase in domestic and tradable prices, decreased competitiveness, and then low effect on output. Excess liabilities in foreign currency can also be represented by a small . If is small and positive, the central bank has less fear of floating. Yet a big depreciation means a negative , and this increases the fear of floating.

Figure 2.1: Developed countries’ optimal path for GDP and inflation

Figure 2.2: Developed countries’ optimal path for GDP and inflation

Figures 2.1 and 2.2 show the paths for output and inflation after optimization at t=1, the targets were not hit本论文由英语论文网提供整理，提供论文代写，英语论文代写，代写论文，代写英语论文，代写留学生论文，代写英文论文，留学生论文代写相关核心关键词搜索。