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International frictions and optimal monetary policy cooperation: analytical solutions

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  • Darracq Pariès, Matthieu

Abstract

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

Suggested Citation

  • Darracq Pariès, Matthieu, 2007. "International frictions and optimal monetary policy cooperation: analytical solutions," Working Paper Series 834, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:2007834
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    References listed on IDEAS

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    1. Maurice Obstfeld & Kenneth Rogoff, 2002. "Global Implications of Self-Oriented National Monetary Rules," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 503-535.
    2. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2008. "International Risk Sharing and the Transmission of Productivity Shocks," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 443-473.
    3. Stepahnie Schmitt-Grohé & Martín Uribe, 2007. "Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 5, pages 125-186 Central Bank of Chile.
    4. Ester Faia & Tommaso Monacelli, 2003. "Ramsey monetary policy and international relative prices," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    5. 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.
    6. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
    7. 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.
    8. 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.).
    9. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, February.
    10. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare and Macroeconomic Interdependence," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 421-445.
    11. 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.
    12. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
    13. Benigno, Pierpaolo & Woodford, Michael, 2012. "Linear-quadratic approximation of optimal policy problems," Journal of Economic Theory, Elsevier, vol. 147(1), pages 1-42.
    14. repec:hrv:faseco:34721962 is not listed on IDEAS
    15. Benigno, Gianluca, 2004. "Real exchange rate persistence and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 473-502, April.
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    Cited by:

    1. Adjemian, Stéphane & Darracq Pariès, Matthieu & Smets, Frank, 2008. "A quantitative perspective on optimal monetary policy cooperation between the US and the euro area," Working Paper Series 884, European Central Bank.

    More about this item

    Keywords

    DSGE models; New open economy macroeconomics.; optimal monetary policy;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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