Economics: The Open-Access, Open Assessment E-Journal http://www.economics-ejournal.org en Markus Lahtinen Petri Mäki-Fränti The Exchange Rate Targeting of Central Banks Revised: The Role of Long-term Interest Rates 2007-07-10 Using a New Keynesian macro model, the paper reconsiders the question, whether the central banks should directly respond to exchange rate movements. It is assumed that the transmission of monetary policy to output is carried out by the long-term interest rate, which is determined as a sum of expectations of short-term interest rates and a non-negligible term premium. According to the results, the central banks could gain from stabilizing the exchange rate movements more than suggested in the previous literature. The welfare gains are more clearly seen in the reduced volatility of inflation than stabilization of output, however. Paper submitted to the special issue " Recent Developments in International Money and Finance " edited by Ronald MacDonald http://www.economics-ejournal.org/economics/discussionpapers/2007-28 JEL E32 JEL E52 JEL E58