Calculating the Long-Run Constrained Policy Rate
A country with a flexible exchange rate has a long-term inflation target of 2% and aims to maintain a stable real exchange rate. Its main trading partner has a long-term inflation target of 1% and its central bank maintains a long-run nominal interest rate of 3%. To achieve both of its long-term objectives, what nominal interest rate should the first country's central bank set? Briefly justify your reasoning.
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Related
A central bank operating under a flexible exchange rate and an inflation-targeting regime has two primary long-term objectives: maintaining inflation at its target and ensuring a stable real exchange rate. Suppose this central bank decides to permanently set its policy interest rate at a level that is inconsistent with achieving both of these long-term goals simultaneously. Which of the following statements best describes the ultimate consequence of this policy choice?
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A central bank operating with a flexible exchange rate and an inflation-targeting framework retains complete and unconditional autonomy over its domestic policy interest rate in the long run.
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Calculating the Long-Run Constrained Policy Rate