Exchange Rate Dynamics Under Alternative Intervention Rule

Abstract

This paper examines the effects of two alternative intervention rules, the real exchange rate rule and the nominal exchange rate rule, on the behavior of a small open economy. These rules are found to differ in terms of the resulting exchange-rate jumps, deviations from purchasing power parity, and relationships between interest rate and exchange rate movements. Thus, even though these rules have the same steady-state effects, in the short run it makes a difference as to which rule is pursued since they lead to different exchange-rate jumps and hence to different paths that the economy will follow.