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Non-Traded Goods and Monetary Policy Trade-Offs in a Small Open Economy


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  • Claudio Soto


In this paper I develop a small open economy model that is characterized by existence of two domestic sectors. Together with a home traded goods sector we incorporate a non-traded goods sector. In both sectors prices are sticky, and each one is subject to a specific productivity shock. In this setup the flexible price allocation can not be reached by means of a single monetary policy instrument. Therefore, the central bank faces a trade-off between stabilizing inflation in the Nontraded sector and in the home goods sector. In this context, and when the share of non-traded goods is not too high, a simple Taylor rule outperforms a strict inflation-targeting regime. However, both policy rules are dominated by a rule that moves aggressively the interest rate in response to deviation in core inflation. On the other hand, if the share of non-traded goods is high then the model converges to the closed economy case, and, in absence of an exogenous cost push shock, the optimal policy is to completely stabilize consumer price inflation.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 214.

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Date of creation: Jun 2003
Date of revision:
Handle: RePEc:chb:bcchwp:214

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  1. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  2. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers.
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Cited by:
  1. Yuliya Rychalovska, 2008. "The Implications of Structural Asymmetries for Monetary Policy and Welfare in a Small Open Economy: A Linear Quadratic Framework," CERGE-EI Working Papers wp380, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  2. Marcos Antonio Coutinho da Silveira, 2006. "Two-Country New Keynesian DSGE Model: A Small Open Economy as a Limit Case," Discussion Papers 1157, Instituto de Pesquisa Econômica Aplicada - IPEA.


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