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Is Monetary Policy in an Open Economy Fundamentally Different?

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  • Tommaso Monacelli
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    Abstract

    Openness per se requires optimal monetary policy to deviate from the canonical closed-economy principle of domestic price stability, even if domestic prices are the only ones to be sticky. I review this argument using a simple partial equilibrium analysis in an economy that trades in ?nal consumption goods. I then extend the standard open economy New Keynesian model to include imported inputs of production. Production openness strengthens even further the incentive for the policymaker to deviate from strict domestic price stability. With both consumption and production openness variations in the world price of food and in the world price of imported oil act as exogenous cost-push factors. Keywords: openness, trade, imported inputs, consumption imports, exchange rate, monetary policy. JEL Classi?cation Numbers: E52, F41.

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    Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 449.

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    Date of creation: 2012
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    Handle: RePEc:igi:igierp:449

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    1. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2001. "Gaps and Triangles," Working Papers, Banco de Portugal, Economics and Research Department w200102, Banco de Portugal, Economics and Research Department.
    2. Juan Pablo Nicolini & Constantino Hevia, 2004. "Optimal Devaluations," Econometric Society 2004 Latin American Meetings, Econometric Society 337, Econometric Society.
    3. Luis Catão & Roberto Chang, 2010. "World Food Prices and Monetary Policy," NBER Working Papers 16563, National Bureau of Economic Research, Inc.
    4. Ester Faia & Tommaso Monacelli, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Computing in Economics and Finance 2006, Society for Computational Economics 521, Society for Computational Economics.
    5. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: a Quantitative Investigation," Cahiers de recherche, Universite de Montreal, Departement de sciences economiques 9614, Universite de Montreal, Departement de sciences economiques.
    6. Olivier Blanchard & Jordi Galí, 2005. "Real Wage Rigidities and the New Keynesian Model," Working Papers 243, Barcelona Graduate School of Economics.
    7. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
    8. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
    9. Evi Pappa, 2004. "Do the ECB and the Fed really need to cooperate? Optimal monetary policy in a two-country world," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 512, London School of Economics and Political Science, LSE Library.
    10. De Fiore, Fiorella & Liu, Zheng, 2005. "Does trade openness matter for aggregate instability?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(7), pages 1165-1192, July.
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