Monetary policy priorities: Managing exchange rate vs. Inflation control

Authors: Batsukh Tserendorj, Avralt-Od Purevjav, Tuvshinjargal Dagiimaa

Source: Economic research institute

Keywords: Monetary policy framework, Inflation targeting, DSGE model, Exchange rate regime, Policy rules and instruments

Date: 2014-04-01

Mongolian economy’s adopting inflation targeting monetary policy framework, while facing trouble with defining suitable role of the exchange rate in the framework. This paper aimed to suggest an optimal monetary policy priority using a small open economy DSGE model with extension of natural resource sector. The parameters of the model are calibrated using literature, empirical findings of different studies and country specific indicators. We simulated the model with 4 different policy rules to analyze effect in the economy: plain vanilla IT in an open economy, IT in an open economy, IT with exchange rate band and exchange rate based IT. The model allowed us to investigate the effects of demand, supply and monetary policy shocks to the economy. According to our finding, demand and monetary policy shocks created less volatility of inflation and output but high volatility to foreign debt. Supply shock created very high volatility of inflation, interest rate and foreign debt in IT with exchange rate band and exchange rate based IT rules. We recommend the BoM to consider the volatility of exchange rate at some level aside an inflation in the implementation of monetary policy.

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