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Ramsey Monetary Policy and International Relative Prices

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  • Ester Faia
  • Tommaso Monacelli

Abstract

We analyze welfare maximizing monetary policy in a dynamic general equilibrium two-country model with price stickiness and imperfect competition. In this context, a typcial terms of trade externality affects policy interaction between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by an explicit consideration of all the distortions that are relevant to the Ramsey planner. This strategy entails two main advantages. First, it allows an accurate characterization of optimal policy in a economy that evolves around a steady state which is not necessarily efficient. Second, it allows to describe a full range of alternative dynamic equilibria when price setters in both countries are completely forward-looking and households' preferences are not restricted. We study optimal policy both in the long-run and in response to shocks, and we compare commitment under Nash competition and under cooperation. By deriving a second order accurate solution to the policy functions, we also characterize the welfare gains from international policy cooperation.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 254.

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Date of creation: 2004
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Handle: RePEc:igi:igierp:254

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Cited by:
  1. Corsini, Lorenzo & Spataro, Luca, 2011. "Optimal decisions on pension plans in the presence of financial literacy costs and income inequalities," MPRA Paper 30946, University Library of Munich, Germany.
  2. Juan Pablo Nicolini & Constantino Hevia, 2004. "Optimal Devaluations," Econometric Society 2004 Latin American Meetings 337, Econometric Society.
  3. Ester Faia & Tommaso Monacelli, 2008. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 721-750, 06.
  4. Tommaso Monacelli, 2003. "Commitment, Discretion and Fixed Exchange Rates in an Open Economy," Working Papers 233, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. Bianca De Paoli, 2004. "Monetary policy and welfare in a small open economy," LSE Research Online Documents on Economics 19950, London School of Economics and Political Science, LSE Library.
  6. Ruy Lama & Juan Pablo Medina, 2004. "Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices," Working Papers Central Bank of Chile 286, Central Bank of Chile.
  7. Darracq Pariès, Matthieu, 2007. "International frictions and optimal monetary policy cooperation: analytical solutions," Working Paper Series 0834, European Central Bank.
  8. Monacelli, Tommaso, 2003. "Monetary policy in a low pass-through environment," Working Paper Series 0227, European Central Bank.
  9. Giancarlo Corsetti, 2005. "Openness and the case for flexible exchange rates," Economics Working Papers ECO2005/21, European University Institute.
  10. Sebastian Sienknecht, 2010. "On the Informational Loss Inherent in Approximation Procedures: Welfare Implications and Impulse Responses," Jena Economic Research Papers 2010-005, Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics.
  11. Adjemian, Stéphane & Darracq Pariès, Matthieu & Smets, Frank, 2008. "A quantitative perspective on optimal monetary policy cooperation between the US and the euro area," Working Paper Series 0884, European Central Bank.
  12. Kelly Edmiston & Mary Gillett Fisher, 2006. "Financial education at the workplace: evidence from a survey of Federal Reserve Bank employees," Community Affairs Research Working Paper 2006-02, Federal Reserve Bank of Kansas City.

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