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Monetary policy in open economies: Practical perspectives for pragmatic central bankers

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  • Clarida, Richard H.

Abstract

This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary (‘stable’) nominal exchange rate – let alone a fixed exchange rate or one that remains inside a target zone – because, absent a commitment device, optimal monetary can’t deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an ‘inflation’ shock—the ‘bad news god news’ result of Clarida and Waldman (2008. Is Bad News about Inflation Good News for the Exchange Rate. In: John Campbell, (Ed.), Asset Prices and Monetary Policy, Chicago: University of Chicago Press), Clarida and Waldman (2014. Bad News About Inflation is Good News for the Nominal Exchange Rate Under Optimal Monetary Policy: DSGE Theory and a Decade of Empirical Evidence). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.

Suggested Citation

  • Clarida, Richard H., 2014. "Monetary policy in open economies: Practical perspectives for pragmatic central bankers," Journal of Economic Dynamics and Control, Elsevier, vol. 49(C), pages 21-30.
  • Handle: RePEc:eee:dyncon:v:49:y:2014:i:c:p:21-30
    DOI: 10.1016/j.jedc.2014.09.036
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    References listed on IDEAS

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    Cited by:

    1. Martínez-García, Enrique, 2015. "On the sustainability of exchange rate target zones with central parity realignments," Economics Letters, Elsevier, vol. 134(C), pages 86-89.
    2. Richard H. Clarida, 2017. "The Global Factor in Neutral Policy Rates: Some Implications for Exchange Rates, Monetary Policy, and Policy Coordination," NBER Working Papers 23562, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Exchange rates; International finance; Monetary economics;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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