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Should the Exchange Rate be in the Monetary Policy Objective Function?

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  • Tatiana Kirsonova
  • Campbell Leith
  • Simon Wren-Lewis

Abstract

Following from Woodford’s derivation of a benevolent monetary policy maker’s objective function from agents utility, a number of papers have suggested that policy in an open economy should have the same objectives as in a closed economy, and in particular that the exchange rate should play no role. We show that this conclusion is not robust to the presence of any shocks to International Risk Sharing. When such shocks are important, the exchange rate appears alongside output and inflation in the social welfare function. However the form of this target is rather different from that used by a number of authors.

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Bibliographic Info

Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2004_7.

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Date of creation: Nov 2004
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Handle: RePEc:gla:glaewp:2004_7

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  1. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
  2. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  3. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  4. Currie, David & Wren-Lewis, Simon, 1989. "Evaluating Blueprints for the Conduct of International Macro Policy," American Economic Review, American Economic Association, vol. 79(2), pages 264-69, May.
  5. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 743-764, October.
  6. Jordi Gali & Tommaso Monacelli, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," NBER Working Papers 8905, National Bureau of Economic Research, Inc.
  7. Pappa, Evi, 2004. "Do the ECB and the fed really need to cooperate? Optimal monetary policy in a two-country world," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 753-779, May.
  8. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
  9. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
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Cited by:
  1. Tatiana Kirsanova & Mathan Satchi & David Vines & Simon Wren-Lewis, 2007. "Optimal Fiscal Policy Rules in a Monetary Union," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1759-1784, October.
  2. Titiana Kirsanova & David Vines & Mathan Satchi & Simon Wren-Lewis, 2005. "Inflation Persistence, Fiscal Constraints and Non-cooperative Authorities Stabilization Policy in a Monetary Union," Money Macro and Finance (MMF) Research Group Conference 2005 17, Money Macro and Finance Research Group.

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