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Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles

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Kollmann, Robert

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Abstract

This Paper computes welfare maximizing Taylor-style interest rate rules, in a business cycle model of a small open economy. The model assumes staggered price setting and shocks to domestic productivity, to the world interest rate, to world inflation and to the uncovered interest rate parity condition. Optimized policy rules have a pronounced anti-inflation stance and entail significant nominal and real exchange rate volatility. The country responds to an increase in external volatility by holding more foreign assets. The policy rule affects the variance and the mean of consumption. The effect on the mean matters significantly for welfare.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3279.

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Date of creation: Mar 2002
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Handle: RePEc:cpr:ceprdp:3279

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Related research
Keywords: business cycles; interest rate rules; Open economy;

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Find related papers by JEL classification:
E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
F30 - International Economics - - International Finance - - - General
F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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