Monetary policy, exchange rate and stability

Abstract

In inflation targeting, it is difficult to manage the relation between monetary policy and the exchange rate. If the central bank pays attention to this connection, it may be under criticism that they are targeting the exchange rate and not inflation. Our paper discusses an element of the relation between monetary policy and the exchange rate which has been overlooked to date. The difference between domestic and Euro interest rates are in close correlation with exchange rate volatility. What it also means is that interest rate policy has a significant impact on market stability.