Short-run independence of monetary policy under a pegged-exchange-rates system: An econometric approach

Abstract

In this paper we focus on the loss of independence of monetary policy due to the substitutability of domestic and foreign assets, and estimate it for seven main industrial countries under a Bretton Woods period. For that, we develop a structural model of the economy which includes the behavior of the monetary authorities and we consider three different estimates of independence of monetary policy. We find that when exchange rate expectations variables are left out of the equations, then the three estimates widely diverge, which emphasizes the error we can make if we just consider one type of estimate. On the other hand, when these variables are introduced in the model, the three estimates indicate that a large amount of independence exists.