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Asset Market Structures and Monetary Policy in a Small Open Economy

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  • Yongseung Jung
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    Abstract

    This paper sets up a canonical new Keynesian small open economy model with nominal price rigidities to explore the impact of habit persistence and exchange rate pass-through on the welfare ranking of alternative monetary policy rules. It identifies three factors that can affect the welfare ranking: the degree of habit persistence, the degree of exchange rate pass-through, and labor supply elasticity. In contrast to the findings of De Paoli (2009a, 2009b), the analysis reveals a reversal in the welfare ranking of alternative monetary policy rules for unitary intertemporal and intratemporal elasticities of substitution, depending on the asset market structures of small open economies with external habit. The paper also finds that exchange rate pegging outperforms domestic producer price index inflation targeting at high degrees of intratemporal elasticity of substitution and external habit, regardless of asset market structures. Finally, the paper finds that exchange rate pegging outperforms domestic or consumer price index inflation targeting if the exchange rate is misaligned.

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    Bibliographic Info

    Paper provided by eSocialSciences in its series Working Papers with number id:3104.

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    Date of creation: Nov 2010
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    Handle: RePEc:ess:wpaper:id:3104

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    Related research

    Keywords: Keynesian; economy; monetary policy; market structures; consumer price index;

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    1. Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2854, C.E.P.R. Discussion Papers.
    2. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers, Rutgers University, Department of Economics 200115, Rutgers University, Department of Economics.
    3. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers, Princeton, Woodrow Wilson School - Public and International Affairs 193, Princeton, Woodrow Wilson School - Public and International Affairs.
    4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 2002. "A Simple Framework for International Monetary Policy Analysis," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3355, C.E.P.R. Discussion Papers.
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    8. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-Through," Working Paper Series 179, Sveriges Riksbank (Central Bank of Sweden).
    9. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
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    11. Bianca De Paoli, 2009. "Monetary policy under alternative asset market structures: the case of a small open economy," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 28595, London School of Economics and Political Science, LSE Library.
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    14. Bianca De Paoli, 2004. "Monetary policy and welfare in a small open economy," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 19950, London School of Economics and Political Science, LSE Library.
    15. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
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    19. Ester Faia & Tommaso Monacelli, 2008. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(4), pages 721-750, 06.
    20. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, American Economic Association, vol. 90(3), pages 356-366, June.
    21. Nelson, Edward, 2002. "Comment on: A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(5), pages 905-912, July.
    22. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version," NBER Working Papers 12402, National Bureau of Economic Research, Inc.
    23. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, American Economic Association, vol. 67(3), pages 297-308, June.
    24. Mathias Trabandt & Karl Walentin & Lawrence J. Christiano, 2008. "Introducing Financial Frictions and Unemployment into a Small Open Economy Model," 2008 Meeting Papers 423, Society for Economic Dynamics.
    25. Stock, James H. & Watson, Mark W., 1999. "Business cycle fluctuations in us macroeconomic time series," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 1, pages 3-64 Elsevier.
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