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Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices

  • McCallum, Bennett T
  • Nelson, Edward

The ‘new open-economy macroeconomics’ seeks to provide an improved basis for monetary and exchange-rate policy through the construction of open-economy models that feature rational expectations, optimizing agents, and slowly adjusting prices of goods. This Paper promotes an alternative approach for constructing such models by treating imports not as finished consumer goods but rather as raw-material inputs to the home economy’s productive process. This treatment leads to a clean and simple theoretical structure that has some empirical attractions as well. A particular small-economy model is calibrated and its properties exhibited, primarily by means of impulse response functions. The preferred variant is shown to feature a pattern of correlations between exchange-rate changes and inflation that is more realistic than provided by a more standard specification. Important recent events are interpreted in light of the alternative models.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2756.

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Date of creation: Apr 2001
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Handle: RePEc:cpr:ceprdp:2756
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  1. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
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  9. Bennett T. McCallum, 2001. "Inflation targeting and the liquidity trap," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  10. Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One Decade of Inflation Targeting in the World: What Do We Know and What Do We Need to Know?," NBER Working Papers 8397, National Bureau of Economic Research, Inc.
  11. David Vines, 2007. "James Meade," Economics Series Working Papers 330, University of Oxford, Department of Economics.
  12. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies.
  13. Bennett T. McCallum, 2001. "Inflation Targeting and the Liquidity Trap," NBER Working Papers 8225, National Bureau of Economic Research, Inc.
  14. Nicoletta Batini & Richard Harrison & Stephen P. Millard, 2001. "Monetary policy rules for an open economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  15. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
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  20. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: A Quantitative Investigation," Cahiers de recherche 9614, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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  23. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 277, Federal Reserve Bank of Minneapolis.
  24. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  25. Lars E.O. Svensson & Sweder van Wijnbergen, 1987. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," NBER Working Papers 2262, National Bureau of Economic Research, Inc.
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  27. R. Barrell & R. Anderton & GM Caporale & JW in't Veld, 1993. "The World Economy," National Institute Economic Review, National Institute of Economic and Social Research, vol. 143(1), pages 27-53, February.
  28. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  29. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
  30. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56 National Bureau of Economic Research, Inc.
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  41. repec:sae:niesru:v:145:y::i:1:p:43-63 is not listed on IDEAS
  42. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1987. "International real business cycles," Working Papers 426, Federal Reserve Bank of Minneapolis.
  43. Bennett T. McCallum, 1999. "Recent developments in the analysis of monetary policy rules," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 3-12.
  44. Raf Wouters & Frank Smets, 2000. "Optimal Monetary Policy In An Open Economy," Computing in Economics and Finance 2000 186, Society for Computational Economics.
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