EXCHANGE RATE DYNAMICS AND MONETARY POLICY IN A SMALL OPEN ECONOMY: A DSGE MODEL FOR KAZAKHSTAN

Abstract

Shift to floating exchange rate regime is controversial decision to commodity oriented economy of Kazakhstan. Increase in volatility of nominal exchange rate is believed to bring deterioration of main macroeconomic variables and reduction of welfare. This paper thus aims to define optimal monetary policy in estimated small open economy of Kazakhstan. On a foundation of Taylor rule and under two specifications of the model it is found that currently National Bank of Kazakhstan reacts to movements in exchange rate on a limited extent. In addition, optimal policy simulation based on posterior distribution of model parameters and welfare loss minimization function is performed. This analysis shows that exchange rate stabilization within 5% band delivers lowest welfare loss.