Optimal MOnetary Policy Rules when the Current Account Matters

This paper explores the implications for optimal monetary policy rules of including a target for the current account (CA) among central bank (CB) objectives. Using a simple but realistic macroeconomic model of the Chilean economy and standard dynamic programming with forward looking variables, the paper finds optimal rules under alternative specifications of a CB quadratic loss-function. The results show that optimal policy reactions change substantially when there is an objective for the CA (besides inflation). Furthermore, once the CA enters the CB objective function, the relative importance of output vis-à-vis inflation variability is less crucial in determining optimal policy rules. Using a simple 2-equation model, the paper then investigates the implications for monetary policy of having an asymmetric objective with respect to the CA. Specifically, it considers the case in which negative deviations from target are considered to be relatively more costly. The results indicate that, in this non-quadratic set-up, monetary policy is clearly more aggressive against positive inflation shocks than in the symmetric case.(This abstract was borrowed from another version of this item.)