Reaction function under fixed exchange rate system.

Abstract

The paper presents the viewpoint that the monetary policy reaction function can be constructed when a country adopts the exchange-rate targeting. Though this is different from a common understanding of monetary policy’s ineffectiveness, there are a few reasons to believe that the authority still has some freedom in conducting the policy. First, the assumption of perfect capital mobility may be not realistic. Second, even when the authority publicly announces the pegged rate, the promise may not always be kept. Third is when the authority employs a sterilized intervention. To understand how the policy is actually conducted, the reaction function is a simple approach since it shows how a central bank uses the tools to achieve macroeconomic goals. As for the case of Thailand, the function shows that although the Bank of Thailand announced the exchange-rate targeting prior to 1997, the output goal was also pursued as well.