Instrument rules in monetary policy under heterogeneity in currency trade

We embed different instrument rules into Gali and Monacelli's new Keynesian model for a small open economy that is augmented with technical trading in currency trade to examine the prerequisites for monetary policy. Specifically, conditions for a determinate and least squares learnable REE are in focus. When a contemporaneous data specification of the rule is usedinpolicy-making, the degree of trend following in currency trade does not affect these conditions, except in case of an extensive use of trend following, whereas a forward expectations specification makes it less likely to have a determinate and learnable REE when the degree of trend following is increasing. We allow for interest rate inertia in the analysis. (C) 2008 Elsevier Inc. All rights reserved.