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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 two-country model with price stickiness and imperfect competition. In this context, a typical 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 an 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. In this context, we study optimal policy both in the long-run and along a dynamic path, and we compare optimal commitment policy 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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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 249.

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Date of creation: 2004
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Handle: RePEc:red:sed004:249

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Keywords: Optimal Monetary Policy; Ramsey planner; Nash equilibrium; Cooperation; sticky prices; imperfect competition.;

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References

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Citations

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Cited by:
  1. Tommaso Monacelli, 2003. "Monetary policy in a low pass-through environment," Working Paper Series 227, European Central Bank.
  2. 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.
  3. Constantino Hevia, 2011. "Optimal Devaluations," 2011 Meeting Papers 1070, Society for Economic Dynamics.
  4. Matthieu Darracq Pariès, 2007. "International frictions and optimal monetary policy cooperation - analytical solutions," Working Paper Series 834, European Central Bank.
  5. Corsetti, Giancarlo, 2006. "Openness and the case for flexible exchange rates," Research in Economics, Elsevier, vol. 60(1), pages 1-21, March.
  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. 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.
  8. Frank Smets & Matthieu Darracq Pariès & Stéphane Adjemian, 2008. "A quantitative perspective on optimal monetary policy cooperation between the US and the euro area," Working Paper Series 884, European Central Bank.
  9. 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.

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