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Optimal inflation in an open economy with imperfect competition

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  • David M. Arseneau

Abstract

This paper uses a two-country, monetary general equilibrium model with imperfect competition to study the optimal rate of inflation in an open economy. In contrast with the closed economy literature, when policy is set non-cooperatively in the open economy, the optimality of the Friedman rule is not a general result. Monetary authorities face an incentive to use the inflation tax to gain a "beggar-thy-neighbor" advantage over the terms of trade. Strategic use of the inflation tax, however, results in coordination failure. International monetary cooperation helps to mitigate this coordination failure and, as a result, can lead to more efficient equilibria. Monetary union ensures the maximum gain from cooperation by restoring the optimality of the global Friedman rule, placing the world economy at the Pareto frontier.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2004-25.

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Date of creation: 2004
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Handle: RePEc:fip:fedgfe:2004-25

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Keywords: Monetary policy ; Inflation (Finance);

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References

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  1. Ireland, Peter N., 1997. "Sustainable monetary policies," Journal of Economic Dynamics and Control, Elsevier, vol. 22(1), pages 87-108, November.
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  16. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2002. "The Need for International Policy Coordination: What's Old, What's New, What's Yet to Come?," NBER Working Papers 8765, National Bureau of Economic Research, Inc.
  17. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  18. Dupor, Bill, 2003. "Optimal random monetary policy with nominal rigidity," Journal of Economic Theory, Elsevier, vol. 112(1), pages 66-78, September.
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Cited by:
  1. Gianluca Benigno & Bianca De Paoli, 2010. "On the International Dimension of Fiscal Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(8), pages 1523-1542, December.
  2. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.

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