Alternative Monetary Rules in the Open Economy: A Welfare-Based Approach
In: Inflation Targeting: Desing, Performance, Challenges
AbstractUsing 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 agentsâ 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.
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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.
Other versions of this item:
- Eric Parrado & Andrés Velasco, 2001. "Alternative Monetary Rules in the Open-Economy: a Welfare-Based Approach," Working Papers Central Bank of Chile 129, Central Bank of Chile.
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