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Alternative Monetary Rules in the Open Economy: A Welfare-Based Approach

In: Inflation Targeting: Desing, Performance, Challenges

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  • Eric Parrado

    (Ministerio de Hacienda, Gobierno de Chile)

  • Andrés Velasco

    (Ministerio de Hacienda, Gobierno de Chile)

Abstract

Using an optimizing model we compare alternative monetary policy rules and exchange rate regimes for a small stochastic open economy with imperfect competition and short run price rigidity. The criteria to choose among rules and regimes are obtained using a welfare criterion derived from the utility function of the representative agent. The main findings of this paper are that, depending on what shocks affect this economy, the effects of inflation targeting on output and inflation volatility depend crucially on the exchange rate regime and the inflation index being targeted. With regard to the exchange rate, we find that the loss in agents’ welfare is much higher under managed exchange rates than under flexible rates in presence of real shocks, while for nominal shocks the reverse is true. As far as the definition of inflation targeting index is concerned, domestic inflation appears to outperform the CPI. Finally, flexible inflation targeting is welfare superior to strict targeting.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Eric Parrado & Andrés Velasco, 2002. "Alternative Monetary Rules in the Open Economy: A Welfare-Based Approach," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.), Inflation Targeting: Desing, Performance, Challenges, edition 1, volume 5, chapter 7, pages 295-348 Central Bank of Chile.
  • Handle: RePEc:chb:bcchsb:v05c07pp295-348
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    References listed on IDEAS

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    5. Mario I. Blejer & Alfredo M. Leone & Pau Rabanal & Gerd Schwartz, 2002. "Inflation Targeting in the Context of IMF-Supported Adjustment Programs," IMF Staff Papers, Palgrave Macmillan, vol. 49(3), pages 1-2.
    6. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
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    12. Richard H. Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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    Cited by:

    1. Jose De Gregorio & Andrea Tokman R., 2004. "Overcoming Fear of Floating: Exchange Rate Policies in Chile," Working Papers Central Bank of Chile 302, Central Bank of Chile.
    2. Federico Ravenna, 2005. "The European Monetary Union as a Commitment Device for New EU Member States," Working Papers 98, Oesterreichische Nationalbank (Austrian Central Bank).
    3. Rodrigo Caputo & Felipe Liendo & Juan Pablo Medina, 2006. "New Keynesian Models For Chile During The Inflation Targeting Regime: A Structural Approach," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 9(3), pages 73-95, December.
    4. Eric Parrado, 2004. "Singapore's Unique Monetary Policy; How Does it Work?," IMF Working Papers 04/10, International Monetary Fund.
    5. José De Gregorio R. / & Andrea Tokman R., 2005. "Fear of Floating and Exchange Rate Policy in Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 8(3), pages 29-54, December.
    6. Macarena García & Pablo García & Bernardita Piedrabuena, 2005. "Fiscal and Monetary Policy Rules: The Recent Chilean Experience," Working Papers Central Bank of Chile 340, Central Bank of Chile.

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