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Is Monetary Policy in an Open Economy Fundamentally Different?

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  • Tommaso Monacelli
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    Abstract

    Openness requires optimal monetary policy to deviate from the canonical closed economy principle of domestic price stability, even if domestic prices are the only ones to be sticky. The paper reviews this argument using a simple partial equilibrium analysis in an economy that trades in final consumption goods. It then extends the standard open economy New Keynesian model to include imported inputs of production. Production openness strengthens even further the incentive for the policymaker to deviate from strict domestic price stability. With both consumption and production openness, variations in the world price of food and in the world price of imported oil act as exogenous cost-push factors.

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    Bibliographic Info

    Article provided by Palgrave Macmillan in its journal IMF Economic Review.

    Volume (Year): 61 (2013)
    Issue (Month): 1 (April)
    Pages: 6-21

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    Handle: RePEc:pal:imfecr:v:61:y:2013:i:1:p:6-21

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    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.:
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    1. Olivier Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Working Papers 05-14, Federal Reserve Bank of Boston.
    2. Bernardino Adao, 2000. "Gaps and Triangles," Econometric Society World Congress 2000 Contributed Papers 1904, Econometric Society.
    3. 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.
    4. Kollmann, R., 1996. "The Exchange rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: A Quantitative Investigation," Discussion Paper 1996-67, Tilburg University, Center for Economic Research.
    5. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
    6. Juan Pablo Nicolini & Constantino Hevia, 2004. "Optimal Devaluations," Econometric Society 2004 Latin American Meetings 337, Econometric Society.
    7. Roberto Chang & Luis Catão, 2010. "World Food Prices and Monetary Policy," IMF Working Papers 10/161, International Monetary Fund.
    8. Ester Faia & Tommaso Monacelli, 2008. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 721-750, 06.
    9. Bernardino Ad�o & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 699-713.
    10. Sutherland, Alan, 2002. "Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability," CEPR Discussion Papers 3431, C.E.P.R. Discussion Papers.
    11. Bennett T. McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," NBER Working Papers 8175, National Bureau of Economic Research, Inc.
    12. De Fiore, Fiorella & Liu, Zheng, 2005. "Does trade openness matter for aggregate instability?," Journal of Economic Dynamics and Control, Elsevier, vol. 29(7), pages 1165-1192, July.
    13. 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.
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    Cited by:
    1. Zheng Liu & Mark M. Spiegel, 2013. "Monetary policy regimes and capital account restrictions in a small open economy," Working Paper Series 2013-33, Federal Reserve Bank of San Francisco.
    2. Samuel Wills, 2014. "Optimal Monetary Responses to Oil Discoveries," OxCarre Working Papers 121, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.

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