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International Policy Coordination and Simple Monetary Policy Rules

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  • Wolfram Berger

Abstract

This paper studies monetary policy in an optimizing two-country model. We suppose a two-step production process that is associated with vertical trade. Prices of final consumption goods are sticky and pass-through can be incomplete. Monetary authorities should respond to both home and foreign shocks in this set-up. Which simple, i.e. non-optimal, targeting rule best supports the welfare maximizing policy hinges critically on the degree of the cross-country interdependence in production and the relative importance of productivity and cost-push shocks. We argue that the relative volatility of productivity and cost-push shocks determines whether the monetary authority should follow a price targeting rule whereas the degree of vertical integration determines which simple price targeting rule (producer or consumer price index targeting) is best.

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Bibliographic Info

Article provided by Swiss Society of Economics and Statistics (SSES) in its journal Swiss Journal of Economics and Statistics.

Volume (Year): 146 (2010)
Issue (Month): II (June)
Pages: 451-479

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Handle: RePEc:ses:arsjes:2010-ii-2

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Keywords: policy coordination; policy rule; consumer price targeting; producer price targeting; monetary targeting;

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References

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  1. 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.
  2. 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.
  3. 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.
  4. Parsley, David C. & Wei, Shang-Jin, 2001. "Explaining the border effect: the role of exchange rate variability, shipping costs, and geography," Journal of International Economics, Elsevier, vol. 55(1), pages 87-105, October.
  5. Jose Manuel Campa & Linda S. Goldberg & Jose M. Gonzalez-Minguez, 2005. "Exchange rate pass-through to import prices in the Euro area," Staff Reports 219, Federal Reserve Bank of New York.
  6. Corsetti, Giancarlo & Pesenti, Paolo, 2002. "International Dimensions of Optimal Monetary Policy," CEPR Discussion Papers 3349, C.E.P.R. Discussion Papers.
  7. 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.
  8. 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.
  9. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
  10. David Hummels & Jun Ishii & Kei-Mu Yi, 1999. "The nature and growth of vertical specialization in world trade," Staff Reports 72, Federal Reserve Bank of New York.
  11. Charles Engel & John H. Rogers, 1999. "Deviations from Purchasing Power Parity:Causes and Welfare Costs," Working Papers 0038, University of Washington, Department of Economics.
  12. Harold L. Cole & Maurice Obstfeld, 1991. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  13. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Series 0128, European Central Bank.
  14. Kei-Mu Yi, 2000. "Can vertical specialization explain the growth of world trade?," Staff Reports 96, Federal Reserve Bank of New York.
  15. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc.
  16. Alan Sutherland, 2005. "Cost-push shocks and monetary policy in open economies," Oxford Economic Papers, Oxford University Press, vol. 57(1), pages 1-33, January.
  17. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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