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Asset Market Structures and Monetary Policy in a Small Open Economy

  • Yongseung Jung

    (Asian Development Bank Institute)

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    This paper sets up a canonical new Keynesian small open economy model with nominal price rigidities to explore the impact of habit persistence and exchange rate pass-through on the welfare ranking of alternative monetary policy rules. It identifies three factors that can affect the welfare ranking : the degree of habit persistence, the degree of exchange rate pass-through, and labor supply elasticity. In contrast to the findings of De Paoli (2009a, 2009b), the analysis reveals a reversal in the welfare ranking of alternative monetary policy rules for unitary intertemporal and intratemporal elasticities of substitution, depending on the asset market structures of small open economies with external habit. The paper also finds that exchange rate pegging outperforms domestic producer price index inflation targeting at high degrees of intratemporal elasticity of substitution and external habit, regardless of asset market structures. Finally, the paper finds that exchange rate pegging outperforms domestic or consumer price index inflation targeting if the exchange rate is misaligned.

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    File URL: http://saber.eaber.org/node/22811
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    Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 22811.

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    Date of creation: Jan 2010
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    Handle: RePEc:eab:macroe:22811
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    1. Bianca De Paoli, 2009. "Monetary policy under alternative asset market structures: the case of a small open economy," LSE Research Online Documents on Economics 28595, London School of Economics and Political Science, LSE Library.
    2. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version," NBER Working Papers 12402, National Bureau of Economic Research, Inc.
    3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    4. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
    5. Ester Faia & Tommaso Monacelli, 2008. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 721-750, 06.
    6. Cochrane, John H. & Campbell, John, 1999. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Scholarly Articles 3119444, Harvard University Department of Economics.
    7. Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers 2854, C.E.P.R. Discussion Papers.
    8. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
    9. 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.
    10. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
    11. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    12. Benigno, Pierpaolo & Woodford, Michael, 2006. "Linear-Quadratic Approximation of Optimal Policy Problems," CEPR Discussion Papers 5964, C.E.P.R. Discussion Papers.
    13. Lawrence J. Christiano & Mathias Trabandt & Karl Walentin, 2010. "Introducing financial frictions and unemployment into a small open economy model," FRB Atlanta CQER Working Paper 2010-04, Federal Reserve Bank of Atlanta.
    14. Javier Garcia-Cicco & Roberto Pancrazi & Martin Uribe, 2010. "Real Business Cycles in Emerging Countries?," American Economic Review, American Economic Association, vol. 100(5), pages 2510-31, December.
    15. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
    16. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 879-904, July.
    17. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
    18. Nelson, Edward, 2002. "Comment on: A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 905-912, July.
    19. 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.
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