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The Timeless Perspective vs. Discretion: Theory and Monetary Policy Implications for an Open Economy

Compared to the standard Phillips curve, an open-economy version that features a real exchange rate channel leads to a markedly different target rule in a New Keynesian optimizing framework. Under optimal policy from a timeless perspective (TP) the target rule involves additional history dependence in the form of lagged inflation. The target rule also depends on more parameters, notably the discount factor as well as two IS and two Phillips curve parameters. Stabilization policy in this open economy model is no longer isomorphic to policy in a closed economy. Because of the additional history dependence in an open economy target rule price level targeting is no longer consistent with optimal policy. The gains from commitment are smaller in economies where the real exchange rate channel exerts a direct effect on inflation in the Phillips curve.

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File URL: http://www.econ.canterbury.ac.nz/RePEc/cbt/econwp/1119.pdf
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Paper provided by University of Canterbury, Department of Economics and Finance in its series Working Papers in Economics with number 11/19.

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Length: 36 pages
Date of creation: 13 Apr 2011
Date of revision:
Handle: RePEc:cbt:econwp:11/19
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  1. Bennett T. McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," NBER Working Papers 8175, National Bureau of Economic Research, Inc.
  2. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  3. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  5. Alfred V. Guender & Yu Xie, 2006. "Is There an Exchange Rate Channel in the Forward-Looking Phillips Curve? A Theoretical and Empirical Investigation," Working Papers in Economics 06/16, University of Canterbury, Department of Economics and Finance.
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  7. Nessén, Marianne & Vestin, David, 2000. "Average Inflation Targeting," Working Paper Series 119, Sveriges Riksbank (Central Bank of Sweden).
  8. Bennett T. McCallum & Edward Nelson, 2004. "Timeless perspective vs. discretionary monetary policy in forward-looking models," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 43-56.
  9. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  10. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  11. Henrik Jensen, 2002. "Targeting Nominal Income Growth or Inflation?," American Economic Review, American Economic Association, vol. 92(4), pages 928-956, September.
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  14. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
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  17. Christopher Allsopp & Amit Kara & Edward Nelson, 2006. "U.K. inflation targeting and the exchange rate," Working Papers 2006-030, Federal Reserve Bank of St. Louis.
  18. Tatiana Kirsanova & Campbell Leith & Simon Wren-Lewis, 2006. "Should Central Banks Target Consumer Prices or the Exchange Rate?," Economic Journal, Royal Economic Society, vol. 116(512), pages F208-F231, 06.
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