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Caution or Activism? Monetary Policy Strategies in an Open Economy

Author

Listed:
  • Sarno, Lucio
  • Ellison, Martin
  • Vilmunen, Jouko

Abstract

We examine optimal policy in a two-country model with uncertainty and learning, where monetary policy actions affect the real economy through the real exchange rate channel. Our results show that whether policy should be cautious or activist depends on the size of one country relative to another. If one country is small relative to the other then activism is optimal. In contrast, if the two countries are equal sized then caution prevails. Caution is induced in the latter case because of the interaction between the home and foreign central banks. In a two-country symmetric equilibrium, learning is shown to be detrimental to welfare, implying that optimal policy is cautious.

Suggested Citation

  • Sarno, Lucio & Ellison, Martin & Vilmunen, Jouko, 2004. "Caution or Activism? Monetary Policy Strategies in an Open Economy," CEPR Discussion Papers 4766, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4766
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    Cited by:

    1. Philip Arestis & Alexander Mihailov, 2011. "Classifying Monetary Economics: Fields And Methods From Past To Future," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 769-800, September.
    2. repec:rza:wpaper:11 is not listed on IDEAS
    3. James Bullard & Eric Schaling, 2009. "Monetary Policy, Determinacy, and Learnability in a Two‐Block World Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(8), pages 1585-1612, December.
    4. repec:rza:wpaper:011 is not listed on IDEAS
    5. Eric Schaling & James Bullard, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Computing in Economics and Finance 2005 362, Society for Computational Economics.
    6. Bigio, Saki, 2010. "Learning under fear of floating," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 1923-1950, October.
    7. Li Qin & Moïse Sidiropoulos, 2016. "Robustness of Optimal Interest Rate Rules in an Open Economy," Bulletin of Applied Economics, Risk Market Journals, vol. 3(1), pages 29-46.

    More about this item

    Keywords

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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