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Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability

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Author Info
Alan Sutherland

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Abstract

This paper considers the implications of incomplete exchange rate pass-through for optimal monetary and exchange rate policy. A two-country model is presented which allows an explicit derivation of welfare functions in terms of a weighted sum of the second moments of producer prices and the nominal exchange rate. From a single country perspective the optimal exchange rate variance depends on the degree of pass-through, the size and openness of the economy, the elasticity of labour supply and the volatility of foreign producer prices. The optimal coordinated equilibrium can be supported by requiring national central banks to minimise loss functions which are a weighted sum of the varainces of producer prices and the exchange rate, where the weight on the exchange rate variance depends on the degree of pass-through.

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Paper provided by Department of Economics, University of St. Andrews in its series Discussion Paper Series, Department of Economics with number 0212.

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Date of creation: Dec 2002
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Handle: RePEc:san:wpecon:0212

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Postal: School of Economics and Finance, University of St. Andrews, Fife KY16 9AL
Phone: 01334 462420
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Web page: http://www.st-andrews.ac.uk/economics/

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Related research
Keywords: monetary policy; pass-through; exchange rate variability.;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  2. Sutherland, Alan, 2006. "The expenditure switching effect, welfare and monetary policy in a small open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(7), pages 1159-1182, July. [Downloadable!] (restricted)
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  3. Philippe Bacchetta & Eric van Wincoop, 2001. "A Theory of the Currency Denomination of International Trade," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 01.13, Université de Lausanne, Faculté des HEC, DEEP. [Downloadable!]
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  18. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Price Stability as a Nash Equilibrium in Monetary Open-Economy Models," CEPR Discussion Papers 2757, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  24. 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. [Downloadable!] (restricted)
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  27. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999. [Downloadable!]
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  32. Sorensen, Jan Rose, 1992. " Uncertainty and Monetary Policy in a Wage Bargaining Model," Scandinavian Journal of Economics, Blackwell Publishing, vol. 94(3), pages 443-55.
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