Department of Economics, Shiraz Branch, Islamic Azad University, Shiraz, Iran
The main objective of this paper is to provide a theoretical and empirical framework for monetary policy rule in an open economy. Our model is an optimal but simple forward looking model. Our estimate shows that at least, the trinity of inflation gaps, the structure of the economy and the fiscal policy intervention should be used in each optimal and simple monetary policy reaction function. In this model the gap between domestic inflation and the world inflation make the reaction function appropriate for open economy. Our result especially the value of domestic inflation gap coefficient support the finding of Taylor (1993) and Calarida, Gali and Gertler (2000). Another important finding of this paper is the ability to estimate time-varying long-term interest rate. The fluctuation of the short-term interest rate around the long-term can be used as another important criterion to analyze the conduct of monetary policy.
Monetary Policy Rule, Open Economy, Loss Function, Okun's Law, Purchasing Power Parity
