Alternative Monetary Policy Regimes With Multiple Currency Practices

Abstract

We assess how non-orthodox monetary policy of an economy with multiple currency practices impacts growth and development. The central bank employs two monetary instruments: i) adjustment of the official exchange rate and ii) adjustment of nominal monetary base growth to stabilize the economy through minimizing the inflation and output gaps. A third instrument, intervention in the foreign exchange market, is used to control the exchange rate gap. The main message of this paper is that with a persistent external shock, the MPCs are effective at best in the short-run; while it hurts long-term growth. To reduce the adverse impacts on development, we suggest using the producer price index (PPI) in the monetary instruments instead of the consumer price index (CPI). We find that the PPI results in lower welfare losses. We then show that even under a unified exchange rate regime, the PPI targeting considerably performs better. Finally, we indicate that monetary instruments are more effective in the presence of a fiscal rule.