Advanced Search
MyIDEAS: Login

Optimal Monetary Policy In An Open Economy

Contents:

Author Info

  • Raf Wouters

    (European Central Bank)

  • Frank Smets

    (European Central Bank)

Abstract

This paper analyses optimal monetary policy in a linearised open-economy dynamic general equilibrium model with sticky prices. The model extends a version of the new-Keynesian closed economy model discussed in Rotemberg and Woodford (1997), Goodfriend and King (1997) and Clarida, Gali and Gertler (1999) to an open economy context. Through the interest rate parity condition, changes in the interest rate (the central bank's instrument) have an impact on the exchange rate and the terms of trade, which in turn affects import prices and net exports. We calibrate the model to the euro area economy following the approach by Rotemberg and Woodford (1997). This approach consists of choosing some of the structural parameters of the model to match the empirical transmission mechanism of monetary policy as captured by a VAR. For this purpose we estimate a VAR-model in euro-area wide real GDP, inflation, the real exchange rate and a short-term nominal interest rate. The structural shocks (other than monetary policy shocks) are calculated so as to match the cross-correlations of the four variables implied by the VAR. Using the empirical version of the open-economy DGE model with sticky domestic prices, we then analyse optimal monetary policy. Again, we follow Rotemberg and Woodford (1997) in deriving a welfare criterion based on maximising the welfare of the representative agent in the economy. In contrast to the closed economy analysis of Goodfriend and King (1997) and Aoki (1999), the existence of an exchange rate channel and terms-of-trade effects does create a trade-off between stabilising the output gap and domestic inflation. We examine the empirical relevance of this trade-off and compare the outcome under commitment to the optimal policy with the outcome when various simple instrument and targeting rules that have been explored in the literature are used.

Download Info

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2000 with number 186.

as in new window
Length:
Date of creation: 05 Jul 2000
Date of revision:
Handle: RePEc:sce:scecf0:186

Contact details of provider:
Postal: CEF 2000, Departament d'Economia i Empresa, Universitat Pompeu Fabra, Ramon Trias Fargas, 25,27, 08005, Barcelona, Spain
Fax: +34 93 542 17 46
Email:
Web page: http://enginy.upf.es/SCE/
More information through EDIRC

Related research

Keywords:

References

No references listed on IDEAS
You can help add them by filling out this form.

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
  2. Bennett T. McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," NBER Working Papers 8175, National Bureau of Economic Research, Inc.
  3. Batini, Nicoletta & Harrison, Richard & Millard, Stephen P., 2003. "Monetary policy rules for an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 2059-2094.
  4. Sutherland, Alan, 2001. "Inflation Targeting in a Small Open Economy," CEPR Discussion Papers 2726, C.E.P.R. Discussion Papers.
  5. Neiss, Katharine S. & Nelson, Edward, 2003. "The Real-Interest-Rate Gap As An Inflation Indicator," Macroeconomic Dynamics, Cambridge University Press, vol. 7(02), pages 239-262, April.
  6. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Series 0128, European Central Bank.
  7. Kollmann, Robert, 2002. "Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles," CEPR Discussion Papers 3279, C.E.P.R. Discussion Papers.
  8. Fabio Ghironi, 2000. "Alternative Monetary Rules for a Small Open Economy: The Case of Canada," Boston College Working Papers in Economics 466, Boston College Department of Economics, revised 30 Oct 2000.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:sce:scecf0:186. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.