Optimal Monetary Policy in an Open Economy under Asset Market Segmentation

This paper studies optimal monetary policy in a small open economy under flexible prices. The paper's key innovation is to analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). �In this environment, we study three rules: the optimal state contingent monetary policy; the optimal non-state contingent money growth rule; and the optimal non-state contingent devaluation rate rule. �We compare welfare and the volatility of macro aggegates like consumption, exchange rate, and money under the different rules. �One of our key findings is that amongst non-state contingent rules, policies targeting the exchange rate are, in general, welfare dominated by policies which target monetary aggregates. �Crucially, we find that fixed exchange rates are almost never optimal. �On the other hand, under some conditions, a non-state contingent rule like a fixed money rule can even implement the first-best allocation.