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For countries that have floating exchange rates and free capital mobility, monetary policy has come to play an increasingly vital role in the stabilisation of the economy. Taylor(1993) proposes a simple monetary policy rule whereby the monetary authority adjusts the short-term interest rate the ubiquitous monetary policy instrument – to respond to observed inflation and output fluctuations in the economy. Clarida et al. (1998, 1999, 2000) extend the baseline Taylor rule to account for long and variable lags in monetary policy, where the monetary authority responds to expected future inflation movement. In both specifications, positive and negative inflation and output gaps are implicitly met with evenly weighted policy responses. |
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