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Monetary policy in the open economy revisited: The case for exchange-rate flexibility restored

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Duarte, Margarida
Obstfeld, Maurice

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Abstract

This paper revisits the sticky-price pricing-to-market model of Devereux and Engel [Devereux, M.B., Engel, C., 2003. Monetary policy in the open economy revisited: price setting and exchange-rate flexibility. Review of Economic Studies 70(4), 765-783], in which fixed exchange rates are optimal even in the face of country-specific nonmonetary shocks. We show that this result hinges critically on the Devereux-Engel model's prediction that international consumption levels are perfectly synchronized under flexible prices. Realistic modifications of the model that produce nonsynchronous consumption movements - such as, the presence of nontraded goods - upset the fixed exchange rate prescription even in the absence of an expenditure-switching role of exchange rate changes.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 27 (2008)
Issue (Month): 6 (October)
Pages: 949-957
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Handle: RePEc:eee:jimfin:v:27:y:2008:i:6:p:949-957

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Web page: http://www.elsevier.com/locate/inca/30443

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  1. Roc Armenter & Martin Bodenstein, 2006. "Does the time inconsistency problem make flexible exchange rates look worse than you think?," International Finance Discussion Papers 865, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  2. Devereux, Michael B & Engel, Charles M, 2006. "Expectations and Exchange Rate Policy," CEPR Discussion Papers 5743, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Friberg, Richard & Wilander, Fredrik, 2007. "Price Setting Transactions and the Role of Denominating Currency in FX Markets," Working Paper Series 201, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
  4. Hyeongwoo Kim, 2008. "Country-specific shocks and optimal monetary policy," Economics Bulletin, Economics Bulletin, vol. 5(23), pages 1-9. [Downloadable!]
  5. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2007. "Optimal Monetary Policy and the Sources of Local-Currency Price Stability," RSCAS Working Papers 2007/26, European University Institute. [Downloadable!]
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  6. Corsetti, Giancarlo, 2006. "Openness and the Case for Flexible Exchange Rates," CEPR Discussion Papers 5612, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Adao, Bernardino & Correia, Maria Isabel Horta & Teles, Pedro, 2006. "On the Relevance of Exchange Rate Regimes for Stabilization Policy," CEPR Discussion Papers 5797, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Carlos Cortinhas, 2007. "Exchange Rate Pass-Through in ASEAN: Implications for the Prospects of Monetary Integration in the Region," NIPE Working Papers 2/2007, NIPE - Universidade do Minho. [Downloadable!]
  9. Richard N. Cooper (Paper 1) & Michael Bordo (Paper 2) & Harold James (Paper 2), 2006. "Proposal for a Common Currency among Rich Democracies (Paper 1); One World Money, Then and Now (Paper 2)," Working Papers 127, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
  10. Hevia, Constantino & Nicolini, Juan Pablo, 2009. "Optimal devaluations," Policy Research Working Paper Series 4926, The World Bank. [Downloadable!]
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  11. Bastiaan Verhoef, 2006. "Pricing-to-market, sectoral shocks and gains from monetary cooperation," DNB Working Papers 110, Netherlands Central Bank, Research Department. [Downloadable!]
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