Optimal Monetary Policy Under Heterogeneity In Currency Trade

The authors embed an expectations-based optimal policy rule into a DSGE model for a small open economy that is augmented with trend extrapolation or chartism, which is a form of technical trading, in currency trade to examine the prerequisites for monetary policy. They find that a unique REE that is least-squares learnable is often the outcome when there is a limited amount of trend extrapolation, but that a less flexible inflation rate targeting may cause a multiplicity of REE. They also compute impulse-response functions for key macroeconomic variables to study how the economy returns to steady state after being hit by a shock.