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International Monetary Policy Coordination and Competitive Depreciation: A Re-Evaluation

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Author Info

  • Devereux, M.B.
  • Betts, C.

Abstract

Is there a need for international coordination of monetary policies within the current system of floating exchange rates? In a recent paper, Obstfeld and Rogo (1995) argue that in an environment of sticky prices, and floating exchange rates, monetary policy shocks will generate positive welfare spillovers across countries. This leads to the conclusion that international monetary policy coordination is unnecessary, and may in fact be undesirable, since it nurtures a bias towards high inflation. The present paper shows that these conclusions are dependent on the manner in which prices are set. When firms engage in 'pricing-to-market' (PTM), setting prices in the currency of the buyer, monetary policy tends to have negative welfare spillovers. This gives an incentive to engage in 'competitive depreciation'. In a noncooperative equilibrium, world inflation will be higher, the greater the importance of PTM. With a high degree of PTM, the case for international monetary policy coordination is restored. If PTM is at an intermediate range, however, international monetary coordination may have no consequences at all.

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Bibliographic Info

Paper provided by UBC Department of Economics in its series UBC Departmental Archives with number 99-07.

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Length: 27 pages
Date of creation: 1999
Date of revision:
Handle: RePEc:ubc:bricol:99-07

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Keywords: PRICING ; EXCHANGE RATE ; INTERNATIONAL MONETARY POLICY;

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Cited by:
  1. Carlo Frenquelli, 2006. "Pricing-to-Market and Exchange Rate Dynamics: A Primer," Rivista di Politica Economica, SIPI Spa, vol. 96(6), pages 105-143, November-.
  2. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
  3. Paul Levine & Joseph Pearlman & Peter Welz, 2008. "Robust Inflation-Targeting Rules and the Gains from International Policy Coordination," School of Economics Discussion Papers 0208, School of Economics, University of Surrey.
  4. Corsetti, Giancarlo & Pesenti, Paolo, 2002. "International Dimensions of Optimal Monetary Policy," CEPR Discussion Papers 3349, C.E.P.R. Discussion Papers.
  5. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 765-783, October.
  6. Michael B. Devereux, 2000. "A Simple Dynamic General Equilibrium Analysis of the Trade-off Between Fixed and Floating Exchange Rates," Econometric Society World Congress 2000 Contributed Papers 1544, Econometric Society.
  7. D'Amato, Marcello & Martina, Riccardo, 2005. "Credibility and commitment of monetary policy in open economies," European Journal of Political Economy, Elsevier, vol. 21(4), pages 872-902, December.
  8. Michaelis, Jochen, 2006. "Optimal monetary policy in the presence of pricing-to-market," Journal of Macroeconomics, Elsevier, vol. 28(3), pages 564-584, September.
  9. Yoshiyasu Ono, 2006. "Protective Trade Policies 'Reduce' Employment: A Dynamic Optimization Approach," ISER Discussion Paper 0659, Institute of Social and Economic Research, Osaka University.
  10. Bastiaan Verhoef, 2006. "Pricing-to-market, sectoral shocks and gains from monetary cooperation," DNB Working Papers 110, Netherlands Central Bank, Research Department.
  11. Marlène Isoré, 2011. "International Propagation of Financial Shocks in a Search and Matching Environment," FIW Working Paper series 068, FIW.
  12. Devereux, Michael B, 2000. "A Simple Dynamic General Equilibrium Model Of The Tradeoff Between Fixed And Floating Exchange Rates," CEPR Discussion Papers 2403, C.E.P.R. Discussion Papers.

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