On the Performance of Nominal Income Targeting as a Strategy for Monetary Policy in a Small Open Economy

There is a great deal of support for nominal income targeting in the literature on strategies for monetary policy in a closed economy framework. Is nominal income targeting equally attractive in a small open economy? This paper compares nominal income targeting to alternative monetary policy rules in a stochastic macro model for a small open economy. We find that both, the weighting in the overall price level of the exchange rate and foreign prices and the elasticity of output supplied with respect - to the real exchange rate, are important factors in assessing the attractiveness of nominal income targeting. In a small open economy where the size of both parameters is not negligible, a rule targeting the overall price level may actually be preferred to nominal income targeting.