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Alternative Monetary Rules in the Open Economy: A Welfare-Based Approach

In: Inflation Targeting: Desing, Performance, Challenges

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  • Eric Parrado

    (Ministerio de Hacienda, Gobierno de Chile)

  • Andrés Velasco

    (Ministerio de Hacienda, Gobierno de Chile)

Abstract

Using an optimizing model we compare alternative monetary policy rules and exchange rate regimes for a small stochastic open economy with imperfect competition and short run price rigidity. The criteria to choose among rules and regimes are obtained using a welfare criterion derived from the utility function of the representative agent. The main findings of this paper are that, depending on what shocks affect this economy, the effects of inflation targeting on output and inflation volatility depend crucially on the exchange rate regime and the inflation index being targeted. With regard to the exchange rate, we find that the loss in agents’ welfare is much higher under managed exchange rates than under flexible rates in presence of real shocks, while for nominal shocks the reverse is true. As far as the definition of inflation targeting index is concerned, domestic inflation appears to outperform the CPI. Finally, flexible inflation targeting is welfare superior to strict targeting.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

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This chapter was published in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Inflation Targeting: Desing, Performance, Challenges, , chapter 7, pages 295-348, 2002.

This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v05c07pp295-348.

Handle: RePEc:chb:bcchsb:v05c07pp295-348

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  1. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1750, C.E.P.R. Discussion Papers.
  3. Mario I. Blejer & Alfredo M. Leone & Pau Rabanal & Gerd Schwartz, 2002. "Inflation Targeting in the Context of IMF-Supported Adjustment Programs," IMF Staff Papers, Palgrave Macmillan, vol. 49(3), pages 2.
  4. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, Elsevier, vol. 54(2), pages 235-266, August.
  5. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, Econometric Society, vol. 48(5), pages 1305-11, July.
  6. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers, Stockholm - International Economic Studies 638, Stockholm - International Economic Studies.
  7. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  8. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 28(1), pages 3-24, August.
  9. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  10. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  11. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  12. Ben S. Bernanke & Julio J. Rotemberg, 1997. "NBER Macroeconomics Annual 1997, Volume 12," NBER Books, National Bureau of Economic Research, Inc, number bern97-1.
  13. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  14. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
  15. Eric Parrado, 2004. "Inflation Targeting and Exchange Rate Rules in an Open Economy," IMF Working Papers 04/21, International Monetary Fund.
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Citations

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Cited by:
  1. Eric Parrado, 2004. "Singapore's Unique Monetary Policy," IMF Working Papers 04/10, International Monetary Fund.
  2. Ravenna, Federico, 2005. "The European Monetary Union as a commitment device for new EU member states," Working Paper Series, European Central Bank 0516, European Central Bank.
  3. Jose De Gregorio & Andrea Tokman R., 2004. "Overcoming Fear of Floating: Exchange Rate Policies in Chile," Working Papers Central Bank of Chile, Central Bank of Chile 302, Central Bank of Chile.
  4. José De Gregorio R. / & Andrea Tokman R., 2005. "Fear of Floating and Exchange Rate Policy in Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 8(3), pages 29-54, December.
  5. Rodrigo Caputo & Felipe Liendo & Juan Pablo Medina, 2006. "New Keynesian Models For Chile During The Inflation Targeting Regime: A Structural Approach," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 9(3), pages 73-95, December.
  6. Macarena García & Pablo García & Bernardita Piedrabuena, 2005. "Fiscal and Monetary Policy Rules: The Recent Chilean Experience," Working Papers Central Bank of Chile, Central Bank of Chile 340, Central Bank of Chile.

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