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Inflation targeting rules and welfare in an asymmetric currency area

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  • Lombardo, Giovanni

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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Bibliographic Info

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

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Cited by:
  1. Andrzej Toroj, 2011. "Competitiveness channel in Poland and Slovakia: a pre-EMU DSGE analysis," National Bank of Poland Working Papers, National Bank of Poland, Economic Institute 86, National Bank of Poland, Economic Institute.
  2. 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, International Journal of Central Banking, vol. 4(3), pages 1-28, September.
  3. Jochen Michaelis, 2012. "Optimal Monetary Policy in a Currency Union: The Role of the Cost Channel," MAGKS Papers on Economics, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) 201203, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  4. Arghyrou, Michael G. & Gadea, Maria Dolores, 2012. "The single monetary policy and domestic macro-fundamentals: Evidence from Spain," Journal of Policy Modeling, Elsevier, Elsevier, vol. 34(1), pages 16-34.
  5. Ivan Petrella & Emiliano Santoro, . "Optimal Monetary Policy with Durable Consumption Goods and Factor Demand Linkages," EPRU Working Paper Series, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics 2009-04, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics, revised May 2009.
  6. Agenor, Pierre-Richard & Aizenman, Joshua, 2008. "Capital Market Imperfections and the Theory of Optimum Currency Areas," Santa Cruz Department of Economics, Working Paper Series qt7668j94x, Department of Economics, UC Santa Cruz.
  7. Andrzej Torój, 2010. "Rationality of expectations: another OCA criterion? A DSGE analysis," Working Papers, Ministry of Finance in Poland 8, Ministry of Finance in Poland.
  8. Stéphane Auray & Aurélien Eyquem, 2012. "Welfare Reversal in Monetary Union," Working Papers, Centre de Recherche en Economie et Statistique 2012-33, Centre de Recherche en Economie et Statistique.
  9. Sophocles N. Brissimis & Ifigeneia Skotida, 2007. "Optimal Monetary Policy in the Euro Area in the Presence of Heterogeneity," Working Papers, Bank of Greece 62, Bank of Greece.

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