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International Monetary Policy Coordination and Competitive Depreciation: A Reevaluation

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  • Betts, Caroline
  • Devereux, Michael B

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 Rogoff (1995) argue that in an environment of sticky prices, under 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. Our 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, it follows that 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.

Suggested Citation

  • Betts, Caroline & Devereux, Michael B, 2000. "International Monetary Policy Coordination and Competitive Depreciation: A Reevaluation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 722-745, November.
  • Handle: RePEc:mcb:jmoncb:v:32:y:2000:i:4:p:722-45
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    References listed on IDEAS

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    1. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 379-408.
    2. Matías Tapia & Andrea Tokman, 2004. "Effects of Foreign Exchange Intervention under Public Information: The Chilean Case," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Spring 20), pages 215-256, January.
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    5. Jeffrey Frankel & Andrew Rose, 2002. "An Estimate of the Effect of Common Currencies on Trade and Income," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 437-466.
    6. De Gregorio, Jose & Edwards, Sebastian & Valdes, Rodrigo O., 2000. "Controls on capital inflows: do they work?," Journal of Development Economics, Elsevier, vol. 63(1), pages 59-83, October.
    7. Jay C. Shambaugh, 2004. "The Effect of Fixed Exchange Rates on Monetary Policy," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 301-352.
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    Cited by:

    1. Min Lu, 2012. "Current account dynamics and optimal monetary policy in a two-country economy," International Journal of Monetary Economics and Finance, Inderscience Enterprises Ltd, vol. 5(3), pages 299-324.
    2. Michaelis, Jochen, 2006. "Optimal monetary policy in the presence of pricing-to-market," Journal of Macroeconomics, Elsevier, vol. 28(3), pages 564-584, September.
    3. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
    4. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
    5. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 765-783.
    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. Yoshiyasu Ono, 2006. "Protective Trade Policies 'Reduce' Employment: A Dynamic Optimization Approach," ISER Discussion Paper 0659, Institute of Social and Economic Research, Osaka University.
    8. Yoshiyasu Ono, 2014. "International Economic Interdependence and Exchange-rate Adjustment under Persistent Stagnation," The Japanese Economic Review, Japanese Economic Association, vol. 65(1), pages 70-92, March.
    9. Marlène Isoré, 2011. "International Propagation of Financial Shocks in a Search and Matching Environment," FIW Working Paper series 068, FIW.
    10. 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.
    11. 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.
    12. Dohwa, Kohjiro, 2015. "Optimal monetary policy in an economy with vertical production and trade: An analysis based on the perspective of local currency pricing," Japan and the World Economy, Elsevier, vol. 36(C), pages 11-20.
    13. Bastiaan Verhoef, 2006. "Pricing-to-market, sectoral shocks and gains from monetary cooperation," DNB Working Papers 110, Netherlands Central Bank, Research Department.
    14. David D. VanHoose, 2004. "The New Open Economy Macroeconomics: A Critical Appraisal," Open Economies Review, Springer, vol. 15(2), pages 193-215, April.
    15. 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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