Advanced Search
MyIDEAS: Login

Monetary policy and welfare in a small open economy

Contents:

Author Info

  • De Paoli, Bianca

Abstract

This paper analyzes optimal monetary policy in a small open economy featuring monopolistic competition and nominal rigidities. It shows that the utility-based loss function for this economy can be written as a quadratic expression of domestic inflation, output gap and real exchange rate. The presence of an internal monopolistic distortion and a terms of trade externality drives optimal policy away from domestic inflation targeting and affects the optimal level of exchange rate volatility. When domestic and foreign goods are close substitutes for each other, the optimal policy rule implies lower real exchange rate volatility than a domestic inflation targeting regime. The reverse is true when the elasticity of substitution between goods is low.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/B6V6D-4TN82PF-1/2/9b5343667761aa10ef66077fad23c711
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 77 (2009)
Issue (Month): 1 (February)
Pages: 11-22

as in new window
Handle: RePEc:eee:inecon:v:77:y:2009:i:1:p:11-22

Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/505552

Related research

Keywords: Welfare Loss function Terms of trade externality Optimal monetary policy Small open economy;

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Ester Faia & Tommaso Monacelli, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Computing in Economics and Finance 2006 521, Society for Computational Economics.
  2. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  3. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 765-783.
  4. Paul Bergin & Hyung-Cheol Shin & Ivan Tchakarov, 2005. "Does Exchange Rate Variability Matter for Welfare? A Quantitative Investigation of Stabilization Policies," Working Papers 512, University of California, Davis, Department of Economics.
  5. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal fiscal and monetary policy: equivalence results," Staff Report 403, Federal Reserve Bank of Minneapolis.
  6. Giancarlo Corsetti & Paolo Pesenti, 1997. "Welfare and Macroeconomic Interdependence," NBER Working Papers 6307, National Bureau of Economic Research, Inc.
  7. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2007. "Optimal Monetary Policy and the Sources of Local-Currency Price Stability," NBER Working Papers 13544, National Bureau of Economic Research, Inc.
  8. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 743-764, October.
  9. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  10. Pierpaolo Benigno & Michael Woodford, 2008. "Linear-Quadratic Approximation of Optimal Policy Problems," Discussion Papers 0809-01, Columbia University, Department of Economics.
  11. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  12. Tille, Cedric, 2001. "The role of consumption substitutability in the international transmission of monetary shocks," Journal of International Economics, Elsevier, vol. 53(2), pages 421-444, April.
  13. Jinill Kim & Sunghyun Henry Kim & Andrew Levin, 2001. "Patience, persistence and welfare costs of incomplete markets in open economies," International Finance Discussion Papers 696, Board of Governors of the Federal Reserve System (U.S.).
  14. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  15. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  16. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 533-563.
  17. Bernardino Ad�o & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 699-713.
  18. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  19. Faia, Ester & Monacelli, Tommaso, 2004. "Ramsey monetary policy and international relative prices," Working Paper Series 0344, European Central Bank.
  20. Schmitt-Grohé, Stephanie & Uribe, Martín, 2002. "Closing Small Open Economy Models," CEPR Discussion Papers 3096, C.E.P.R. Discussion Papers.
  21. Sutherland, Alan, 2002. "International monetary policy coordination and financial market integration," Working Paper Series 0174, European Central Bank.
  22. Michael Woodford, 2001. "Inflation Stabilization and Welfare," NBER Working Papers 8071, National Bureau of Economic Research, Inc.
  23. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  24. Constantino Hevia & Juan Pablo Nicolini, 2013. "Optimal devaluations," Working Papers 702, Federal Reserve Bank of Minneapolis.
  25. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 825-860.
  26. Benigno, Gianluca & Benigno, Pierpaolo, 2006. "Designing targeting rules for international monetary policy cooperation," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 473-506, April.
  27. Thomas Lubik & Frank Schorfheide, 2005. "A Bayesian Look at New Open Economy Macroeconomics," Economics Working Paper Archive 521, The Johns Hopkins University,Department of Economics.
  28. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Closed versus Open Economies: An Integrated Approach," NBER Working Papers 8604, National Bureau of Economic Research, Inc.
  29. Galí, Jordi & Gertler, Mark & Lopez-Salido, Jose David, 2002. "Markups, Gaps and the Welfare Costs of Business Fluctuations," CEPR Discussion Papers 3212, C.E.P.R. Discussion Papers.
  30. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
  31. Sutherland, Alan, 2005. "Incomplete pass-through and the welfare effects of exchange rate variability," Journal of International Economics, Elsevier, vol. 65(2), pages 375-399, March.
  32. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  33. Ganelli, Giovanni & Lane, Philip R., 2002. "Dynamic General Equilibrium Analysis: The Open Economy Dimension," CEPR Discussion Papers 3540, C.E.P.R. Discussion Papers.
  34. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," CEPR Discussion Papers 2963, C.E.P.R. Discussion Papers.
  35. Dale Henderson & Jinill Kim, 1999. "Exact Utilities under Alternative Monetary Rules in a Simple Macro Model with Optimizing Agents," International Tax and Public Finance, Springer, vol. 6(4), pages 507-535, November.
  36. Juan Pablo Medina & Ruy Lama, 2005. "Optimal Monetary Policy in a Small Open Economy under Segmented Asset Markets and Sticky Prices," 2005 Meeting Papers 774, Society for Economic Dynamics.
  37. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  38. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
  39. Collard, Fabrice & Juillard, Michel, 2001. "Accuracy of stochastic perturbation methods: The case of asset pricing models," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 979-999, June.
  40. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  41. Svensson, Lars E. O., 2002. "Inflation targeting: Should it be modeled as an instrument rule or a targeting rule?," European Economic Review, Elsevier, vol. 46(4-5), pages 771-780, May.
  42. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  43. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers C95-048, University of California at Berkeley.
  44. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
  45. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  46. Judd, Kenneth L., 1996. "Approximation, perturbation, and projection methods in economic analysis," Handbook of Computational Economics, in: H. M. Amman & D. A. Kendrick & J. Rust (ed.), Handbook of Computational Economics, edition 1, volume 1, chapter 12, pages 509-585 Elsevier.
  47. Duarte, Margarida & Obstfeld, Maurice, 2008. "Monetary policy in the open economy revisited: The case for exchange-rate flexibility restored," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 949-957, October.
  48. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  49. Ben S. Bernanke & Julio J. Rotemberg, 1997. "Editorial in "NBER Macroeconomics Annual 1997, Volume 12"," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 1-6 National Bureau of Economic Research, Inc.
  50. Corsetti, Giancarlo & Pesenti, Paolo, 2002. "International Dimensions of Optimal Monetary Policy," CEPR Discussion Papers 3349, C.E.P.R. Discussion Papers.
  51. David Bowman & Brian M. Doyle, 2003. "New Keynesian, open-economy models and their implications for monetary policy," International Finance Discussion Papers 762, Board of Governors of the Federal Reserve System (U.S.).
  52. Sutherland, Alan, 2002. "A Simple Second-Order Solution Method For Dynamic General Equilibrium Models," CEPR Discussion Papers 3554, C.E.P.R. Discussion Papers.
  53. Devereux, Michael B & Engel, Charles M, 2000. "Monetary Policy In The Open Economy Revisited: Price Setting Rules And Exchange Rate Flexibility," CEPR Discussion Papers 2454, C.E.P.R. Discussion Papers.
  54. Pappa, Evi, 2004. "Do the ECB and the fed really need to cooperate? Optimal monetary policy in a two-country world," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 753-779, May.
  55. Ben S. Bernanke & Julio J. Rotemberg, 1997. "NBER Macroeconomics Annual 1997, Volume 12," NBER Books, National Bureau of Economic Research, Inc, number bern97-1, May.
  56. Adolfson, Malin & Laseen, Stefan & Linde, Jesper & Villani, Mattias, 2007. "Bayesian estimation of an open economy DSGE model with incomplete pass-through," Journal of International Economics, Elsevier, vol. 72(2), pages 481-511, July.
  57. Lubik, Thomas A. & Schorfheide, Frank, 2007. "Do central banks respond to exchange rate movements? A structural investigation," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1069-1087, May.
  58. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  59. Bernardino Adao, 2000. "Gaps and Triangles," Econometric Society World Congress 2000 Contributed Papers 1904, Econometric Society.
  60. David M. Arseneau, 2004. "Optimal inflation in an open economy with imperfect competition," Finance and Economics Discussion Series 2004-25, Board of Governors of the Federal Reserve System (U.S.).
  61. Jens Sondergaard & Pietro Cova, 2004. "When Should Monetary Policy Target The Exchange Rate?," Royal Economic Society Annual Conference 2004 51, Royal Economic Society.
  62. Charles Engel, 2002. "The Responsiveness of Consumer Prices to Exchange Rates And the Implications for Exchange-Rate Policy: A Survey Of a Few Recent New Open-Economy..," NBER Working Papers 8725, National Bureau of Economic Research, Inc.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:inecon:v:77:y:2009:i:1:p:11-22. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.