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Monetary Stabilization Policy in an Open Economy

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  • Miller, Marcus H

Abstract

This paper investigates optimal stabilization policy in a small open economy using a continuous time model in which inflation depends on future monetary policy as well as past inflation. The impact of monetary policy is assumed to operate via real interest rates and the real exchange rate and the setting of real interest rates is chosen so as to minimize quadratic costs of fluctuations in output and inflation, subject to varying expectations in the foreign exchange market. Analytical expressions and simulation results are presented for "time inconsistent" optimal policy, the "dynamic programming" solution, for policy which ignores the exchange rate effects when setting real interest rates, and for the "optimal linear feedback" rule.
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Suggested Citation

  • Miller, Marcus H, 1985. "Monetary Stabilization Policy in an Open Economy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 32(3), pages 220-233, November.
  • Handle: RePEc:bla:scotjp:v:32:y:1985:i:3:p:220-33
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    References listed on IDEAS

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    1. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, pages 108-113.
    2. Willem H. Buiter & Marcus Miller, 1991. "Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation," NBER Chapters,in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 239-277 National Bureau of Economic Research, Inc.
    3. Miller, Marcus & Salmon, Mark, 1985. "Dynamic Games and the Time Inconsistency of Optimal Policy in Open Economies," Economic Journal, Royal Economic Society, vol. 95(380a), pages 124-137, Supplemen.
    4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    5. Willem H. Buiter, 1983. "Optimal and Time-Consistent Polices in Continuous Time Rational Expectations Models," NBER Technical Working Papers 0029, National Bureau of Economic Research, Inc.
    6. Williamson, John, 1985. "On the System in Bretton Woods," American Economic Review, American Economic Association, pages 74-79.
    7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
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    Cited by:

    1. Miller, Marcus & Salmon, Mark, 1990. "When does coordination pay?," Journal of Economic Dynamics and Control, Elsevier, pages 553-569.

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