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Inflation targeting rules and welfare in an asymmetric currency area

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Author Info
Lombardo, Giovanni

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Abstract

This paper studies the effect on monetary policy of a non-homogeneous degree of competition across the (two) members of a monetary union. In particular, we assess the welfare loss brought about by the use of a simple interest rate rule that does not take into account such structural differences. Our results show that, ceteris paribus, the welfare-maximizing central bank should react more aggressively to the inflation pressure generated by the more competitive economy. We extend the results of Benigno (2003) in two ways. First, we show that, if the degree of competition differs across countries, the optimal rule could involve a larger weight on the more ?flexible? country. Second, we allow for a non-unitelastic demand for import. We show that this can alter Benigno?s results even under asymmetric degree of competition. Our study suggests that the size of the welfare losses due to the neglect of these asymmetries crucially depends on their actual combination. Furthermore, we show that if information on the true extent of the asymmetries is incomplete, the symmetric rule could outperform the optimal rule. --

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2004,04.

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Date of creation: 2004
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Handle: RePEc:zbw:bubdp1:1545

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Related research
Keywords: currency area; asymmetries; monetary policy rules; imperfect competition; sticky prices; second-order approximation;

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Find related papers by JEL classification:
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

References listed on IDEAS
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  2. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April. [Downloadable!] (restricted)
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  3. Elizabeth Powers & Nicholas Powers, 2001. "The Size and Frequency of Price Changes: Evidence from Grocery Stores," Review of Industrial Organization, Springer, vol. 18(4), pages 397-416, June. [Downloadable!] (restricted)
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  6. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Paolo Angelini & Paolo Del Giovane & Stefano Siviero & Daniele Terlizzese, 2002. "Monetary Policy Rules for the Euro Area: What Role for National Information?," Temi di discussione (Economic working papers) 457, Bank of Italy, Economic Research Department. [Downloadable!]
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  15. Giancarlo Corsetti & Paolo Pesenti, 2001. "International dimensions of optimal monetary policy," Staff Reports 124, Federal Reserve Bank of New York. [Downloadable!]
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  16. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April. [Downloadable!] (restricted)
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  17. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Relative Price Movements in Dynamic General Equilibrium Models of International Trade," NBER Working Papers 4243, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Roel M.W.J. Beetsma & Henrik Jensen, 2002. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Working Paper Series 166, European Central Bank. [Downloadable!]
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  21. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June. [Downloadable!] (restricted)
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  23. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  29. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Engin Kara, 2009. "Input-output connections between sectors and optimal monetary policy," Research series 200906-25, National Bank of Belgium. [Downloadable!]
  2. Arghyrou, Michael G & Gadea, Maria Dolores, 2008. "The single monetary policy and domestic macro-fundamentals: Evidence from Spain," Cardiff Economics Working Papers E2008/23, Cardiff University, Cardiff Business School, Economics Section. [Downloadable!]
  3. Paolo Angelini & Paolo Del Giovane & Stefano Siviero & Daniele Terlizzese, 2008. "Monetary Policy in a Monetary Union: What Role for Regional Information?," International Journal of Central Banking, International Journal of Central Banking, vol. 4(3), pages 1-28, September. [Downloadable!]
  4. Pierre-Richard Agenor & Joshua Aizenman, 2008. "Capital Market Imperfections and the Theory of Optimum Currency Areas," NBER Working Papers 14088, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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