Optimal Exchange Rate Policy Under Unknown Pass-through and Learning With Applications to Korea

  • Authors:

  • David Hudgins;C. W. Chan

  • Affiliations:

  • Department of Economics, University of Oklahoma, Norman, USA 73019;Department of Economics, University of Oklahoma, Norman, USA 73019

  • Venue:
  • Computational Economics
  • Year:
  • 2008

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Abstract

The purpose of this analysis is to explore optimal monetary and exchange rate policy in continuous time when there is uncertainty in the exchange rate pass-through mechanism. Selecting official reserves as an operating target, optimal feedback control rules are derived using MATLAB Simulink under a stochastic linear-quadratic Gaussian specification with a Kalman observer approach to learning the differing pass-through expectations. The model is estimated using discrete time Korean data, which is transformed into the continuous time model where simulations are applied to the Korean economy.