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Inflation Targeting in a Small Open Economy

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  • Sutherland, Alan

Abstract

A small open economy model is presented, which allows explicit treatment of uncertainty and its effects on macroeconomic behaviour. Inflation targeting is compared to the welfare maximizing monetary rule and to a fixed nominal exchange rate. It is found that flexible inflation targeting produces too little exchange rate volatility compared to the optimal rule but delivers higher welfare than a fixed nominal exchange rate. Strict inflation targeting also delivers higher welfare than a fixed rate. In addition it is found that the welfare-maximizing monetary rule can be replicated if the central bank’s objective function includes the nominal exchange rate.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2726.

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Date of creation: Mar 2001
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Handle: RePEc:cpr:ceprdp:2726

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Related research

Keywords: Inflation Targeting; Monetary Policy; Open Economy;

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References

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  1. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  2. Svensson, L.E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Papers 646, Stockholm - International Economic Studies.
  3. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  4. Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc.
  5. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  6. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  7. Devereux, Michael B & Engel, Charles M, 2000. "Monetary Policy In The Open Economy Revisited: Price Setting Rules And Exchange Rate Flexibility," CEPR Discussion Papers 2454, C.E.P.R. Discussion Papers.
  8. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 765-783, October.
  9. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
  10. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  11. Raf Wouters & Frank Smets, 2000. "Optimal Monetary Policy In An Open Economy," Computing in Economics and Finance 2000 186, Society for Computational Economics.
  12. Vickers, John, 2000. "Monetary Policy and Asset Prices," Manchester School, University of Manchester, vol. 68(0), pages 1-22, Supplemen.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  14. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
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