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International frictions and optimal monetary policy cooperation: analytical solutions

  • Darracq Pariès, Matthieu

This paper analyzes the implications of price-setting and incomplete financial markets for optimal monetary cooperation. The main objective is to provide the basic intuitions concerning the role of the main international frictions on optimal policy within a simple Dynamic Stochastic General Equilibrium model. We concentrate on a symmetric two-country DSGE with home bias, incomplete financial markets internationally and imperfect competition together with nominal price rigidities in which the export prices can be denominated either in the producer currency (PCP) or in the consumer currency (LCP). In addition, the model can account both for efficient and inefficient shocks. Our main results are derived in polar cases with efficient steady state and for which the design of the optimal policy is specifically illustrative and can be expressed in terms of targeting rules. In particular, the paper gives some new insights on the optimal exchange rate regime given the structure of shocks and the exchange rate pass-through, as well as on the optimal stabilization of CPI and PPI inflation. We also put into perspective the implication of financial autarky on the optimal management of international spillovers. JEL Classification: E5, F4

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Paper provided by European Central Bank in its series Working Paper Series with number 0834.

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Date of creation: Nov 2007
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Handle: RePEc:ecb:ecbwps:20070834
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  1. Giancarlo CORSETTI & Luca DEDOLA & Sylvain LEDUC, 2003. "International Risk-Sharing and the Transmission of Productivity Shocks," Economics Working Papers ECO2003/22, European University Institute.
  2. Faia, Ester & Monacelli, Tommaso, 2004. "Ramsey monetary policy and international relative prices," CFS Working Paper Series 2004/04, Center for Financial Studies (CFS).
  3. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
  4. Obstfeld, Maurice & Rogoff, Kenneth, 2001. "Global Implications of Self-Orientated National Monetary Rules," CEPR Discussion Papers 2856, C.E.P.R. Discussion Papers.
  5. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, 02.
  6. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model," NBER Working Papers 11854, National Bureau of Economic Research, Inc.
  7. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare And Macroeconomic Interdependence," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 421-445, May.
  8. Pierpaolo Benigno & Michael Woodford, 2006. "Linear-Quadratic Approximation of Optimal Policy Problems," NBER Working Papers 12672, National Bureau of Economic Research, Inc.
  9. Alan Sutherland, 2002. "International monetary policy coordination and financial market integration," International Finance Discussion Papers 751, Board of Governors of the Federal Reserve System (U.S.).
  10. Benigno, Gianluca & Benigno, Pierpaolo, 2003. "Designing targeting rules for international monetary policy cooperation," Working Paper Series 0279, European Central Bank.
  11. 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.
  12. Benigno, Gianluca, 2004. "Real exchange rate persistence and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 473-502, April.
  13. Giancarlo Corsetti & Paolo Pesenti, 2001. "International Dimensions of Optimal Monetary Policy," NBER Working Papers 8230, National Bureau of Economic Research, Inc.
  14. Michael B. Devereux & Charles Engel, 2005. "Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy," Working Papers 082005, Hong Kong Institute for Monetary Research.
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