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Is Monetary Policy in an Open Economy Fundamentally Different?

  • Tommaso Monacelli

Openness requires optimal monetary policy to deviate from the canonical closed economy principle of domestic price stability, even if domestic prices are the only ones to be sticky. The paper reviews this argument using a simple partial equilibrium analysis in an economy that trades in final consumption goods. It then extends the standard open economy New Keynesian model to include imported inputs of production. Production openness strengthens even further the incentive for the policymaker to deviate from strict domestic price stability. With both consumption and production openness, variations in the world price of food and in the world price of imported oil act as exogenous cost-push factors.

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Article provided by Palgrave Macmillan in its journal IMF Economic Review.

Volume (Year): 61 (2013)
Issue (Month): 1 (April)
Pages: 6-21

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Handle: RePEc:pal:imfecr:v:61:y:2013:i:1:p:6-21
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  1. Bernardino Adão & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 699-713.
  2. Ester Faia & Tommaso Monacelli, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Computing in Economics and Finance 2006 521, Society for Computational Economics.
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  9. Luis Catão & Roberto Chang, 2010. "World Food Prices and Monetary Policy," NBER Working Papers 16563, National Bureau of Economic Research, Inc.
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