Journal of Global Economics, Management and Business Research

The paper examines the choice of the central bank toward the movements of the nominal exchange rate and evaluates its effects on the volatility of the output growth and the inflation. The novel hybrid method of the dynamic stochastic general equilibrium called the DSGE-VAR is proposed for analyzing this policy experiment in a small scale open economy in particular Tunisia. The contribution is provided to the empirical literature as we apply the Tunisian data with this model, which is rarely used in this context. Also treating the issue of the degree of response of the central bank to the exchange rate. To ameliorate the estimation, the Bayesian technique is carried out for the sample 1980:q1 to 2011 q4. Our results reveal that the central bank should not react or softly react to the exchange rate. Also the overall inflation volatility is more pronounced with the fixed exchange rate regime for most of the shocks except for the productivity and the interest rate. Similarly, the output volatility is higher with this regime with the majority of the shocks exempting the foreign interest rate   and the interest rate shocks.