Welfare-Based Optimal Monetary Policy in a Two-Sector Small Open Economy
The paper analyzes the stabilization objectives of optimal monetary policy and the trade-offs facing the central bank in a two-sector small open economy model obtained as a limiting case of a two-country DSGE framework. We introduce a more complicated economic structure, namely, multiple domestic sectors combined with a variety of exogenous shocks. In addition, our model includes a more general specication of consumersâ€™ preferences than has been considered in the literature so far. As a result, we are able to uncover additional welfare effects specic to the open multi-sectoral economy and make a methodological contribution by deriving a utility-based welfare measure and the optimal reaction function of the central bank. We show that the optimal targeting rule is represented by a complex expression that prescribes the response to the appropriate measure of domestic inflation, sectoral output gaps, as well as to the relevant relative prices. We demonstrate that our model generates an endogenous conflict between the objectives of domestic inflation and real exchange rate stabilization in addition to the inflation-output gap policy trade-off common in the literature. Furthermore, we experiment with alternative simple rules and analyze their ability to replicate the optimal solution.
|Date of creation:||Dec 2007|
|Date of revision:|
|Contact details of provider:|| Postal: Na Prikope 28, 115 03 Prague 1|
Phone: 00420 2 2442 1111
Fax: 00420 2 2421 8522
Web page: http://www.cnb.cz/en/research/research_intro/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Pierpaolo Benigno & Michael Woodford, 2005.
"Inflation Stabilization And Welfare: The Case Of A Distorted Steady State,"
Journal of the European Economic Association,
MIT Press, vol. 3(6), pages 1185-1236, December.
- Pierpaolo Benigno & Michael Woodford, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," NBER Working Papers 10838, National Bureau of Economic Research, Inc.
- Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
- Tibor Hledik, 2003. "Modelling the Second-Round Effects of Supply-Side Shocks on Inflation," Working Papers 2003/12, Czech National Bank, Research Department.
- Evi Pappa & Zheng Liu, 2005.
"Gains from International Monetary Policy Coordination: Does It Pay to Be Different?,"
Computing in Economics and Finance 2005
457, Society for Computational Economics.
- Liu, Zheng & Pappa, Evi, 2008. "Gains from international monetary policy coordination: Does it pay to be different?," Journal of Economic Dynamics and Control, Elsevier, vol. 32(7), pages 2085-2117, July.
- Liu, Zheng & Pappa, Evi, 2005. "Gains from international monetary policy coordination: does it pay to be different?," Working Paper Series 0514, European Central Bank.
- Erceg, Christopher & Levin, Andrew, 2006. "Optimal monetary policy with durable consumption goods," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1341-1359, October.
- Giancarlo Corsetti & Paolo Pesenti, 2001.
"International dimensions of optimal monetary policy,"
124, Federal Reserve Bank of New York.
- Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
- Giancarlo Corsetti & Paolo Pesenti, 2001. "International Dimensions of Optimal Monetary Policy," NBER Working Papers 8230, National Bureau of Economic Research, Inc.
- Corsetti, Giancarlo & Pesenti, Paolo, 2002. "International Dimensions of Optimal Monetary Policy," CEPR Discussion Papers 3349, C.E.P.R. Discussion Papers.
- Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
- Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
- Alan Sutherland, 2002.
"Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability,"
Discussion Paper Series, Department of Economics
200212, Department of Economics, University of St. Andrews.
- Sutherland, Alan, 2005. "Incomplete pass-through and the welfare effects of exchange rate variability," Journal of International Economics, Elsevier, vol. 65(2), pages 375-399, March.
- Sutherland, Alan, 2002. "Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability," CEPR Discussion Papers 3431, C.E.P.R. Discussion Papers.
- De Paoli, Bianca, 2009.
"Monetary policy and welfare in a small open economy,"
Journal of International Economics,
Elsevier, vol. 77(1), pages 11-22, February.
- Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
- Bianca De Paoli, 2004. "Monetary policy and welfare in a small open economy," LSE Research Online Documents on Economics 19950, London School of Economics and Political Science, LSE Library.
- Benigno, Gianluca & Benigno, Pierpaolo, 2003.
"Designing targeting rules for international monetary policy cooperation,"
Working Paper Series
0279, European Central Bank.
- Benigno, Gianluca & Benigno, Pierpaolo, 2006. "Designing targeting rules for international monetary policy cooperation," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 473-506, April.
- Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
When requesting a correction, please mention this item's handle: RePEc:cnb:wpaper:2007/16. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jan Babecky)
If references are entirely missing, you can add them using this form.