Simple Monetary Policy Rules for Developing Countries

This paper evaluates the performance of simple monetary policy rules in a calibrated model for the Chilean economy. The monetary regimes considered are: exchange rate peg, money peg, inflation targeting, nontradable inflation targeting, and a Taylor rule. We develop a small open economy model with tradable and nontradable goods, monopolistic competition and staggered prices á la Calvo. Business cycles fluctuations in the economy are driven by three types of shocks: foreign interest rate, productivity, and government expenditure. In this environment, the role of monetary policy is to offset as much as possible the distortions in the economy, namely staggered prices and monopolistic competition. We ranked the rules according to their ablity to smooth consumption and leisure of the representative household. The welfare analysis suggests that, depending on the source of the shock, it is optimal to stabilize either the price of the tradable goods or the nontradable goods. Rules with these targets are welfare superior to other monetary regimes, such as CPI inflation targeting or money peg. Our analysis tend to support some exchange rate intervention in order to achieve an efficient allocation of resources.