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Optimal Monetary Policy in a Currency Union: Implications of a Country-specific Cost Channel

Author

Listed:
  • Jochen Michaelis

    (University of Kassel)

  • Jakob Palek

    (University of Kassel)

Abstract

There is growing empirical evidence that the strength of the cost channel of monetary policy differs across countries. Using a New Keynesian model of a two-country monetary union, we show how the introduction of a cost channel (differential) alters the optimal monetary responses to union-wide and national shocks. The cost channel makes monetary policy less effective in combating inflation, but it is shown that the optimal response to the decline in effectiveness is a stronger use of the instrument. On the other hand, the larger the cost channel differential, the less aggressive will the optimal monetary policy be. For almost all parameter constellations, our welfare analysis suggests a clear-cut ranking of policy regimes: commitment outperforms the Taylor rule, the Taylor rule outperforms strict inflation targeting, and strict inflation targeting outperforms discretion.

Suggested Citation

  • Jochen Michaelis & Jakob Palek, 2014. "Optimal Monetary Policy in a Currency Union: Implications of a Country-specific Cost Channel," MAGKS Papers on Economics 201444, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  • Handle: RePEc:mar:magkse:201444
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    File URL: http://www.uni-marburg.de/fb02/makro/forschung/magkspapers/44-2014_michaelis.pdf
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    References listed on IDEAS

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    Cited by:

    1. Jakob Palek, 2015. "The Optimal Monetary and Fiscal Policy Mix in a Financially Heterogeneous Monetary Union," MAGKS Papers on Economics 201506, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    2. Palek, Jakob, 2015. "The Optimal Monetary and Fiscal Policy Mix in a Financially Heterogeneous Monetary Union," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113047, Verein für Socialpolitik / German Economic Association.
    3. Palek, Jakob & Schwanebeck, Benjamin, 2019. "Optimal monetary and macroprudential policy in a currency union," Journal of International Money and Finance, Elsevier, vol. 93(C), pages 167-186.

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    More about this item

    Keywords

    cost channel; optimal monetary policy; monetary union; open economy macroeconomics;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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