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The role of financial market structure and the trade elasticity for monetary policy in open economies

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  • Katrin Rabitsch

    () (Central European University, Magyar Nemzeti Bank)

Abstract

The degree of international risk sharing matters for how monetary policy should optimally be conducted in an open economy. This is because risk sharing affects the way in which monetary policy is affected by terms of trade considerations. In a standard two-country model with monopolistic competition and nominal rigidities I consider different assumptions on international financial markets – complete markets, financial autarky and a bond economy – and a large region for the crucial parameter of the trade elasticity. There are three main results: one, the prescription of (producer) price stability as the optimal policy is obtained only as a special case, while in general it is optimal to deviate from a strictly zero inflation rate. Two, while gains from international policy coordination are generally small, they become potentially substantial when international risk sharing is poor and wealth effects from shocks across countries are large. And, three, when international financial markets are incomplete, there are also (sometimes considerable) gains over the flexible price allocation achievable.

Suggested Citation

  • Katrin Rabitsch, 2010. "The role of financial market structure and the trade elasticity for monetary policy in open economies," MNB Working Papers 2010/5, Magyar Nemzeti Bank (Central Bank of Hungary).
  • Handle: RePEc:mnb:wpaper:2010/5
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    References listed on IDEAS

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    1. Ester Faia & Tommaso Monacelli, 2008. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 721-750, June.
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    Cited by:

    1. Mykhaylova Olena & Staveley-O’Carroll James, 2014. "International transmission of productivity shocks with nonzero net foreign debt," The B.E. Journal of Macroeconomics, De Gruyter, vol. 14(1), pages 1-46, January.
    2. Corsetti, G. & Dedola, L. & Leduc, S., 2018. "Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-offs," Cambridge Working Papers in Economics 1822, Faculty of Economics, University of Cambridge.
    3. De Paoli, Bianca & Lipinska, Anna, 2012. "Capital controls: a normative analysis," Proceedings, Federal Reserve Bank of San Francisco, issue Nov, pages 1-36.
    4. Staveley-O’Carroll, James & Staveley-O’Carroll, Olena M., 2018. "Exchange rate targeting in the presence of foreign debt obligations," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 113-134.
    5. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2018. "Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-off," Discussion Papers 1806, Centre for Macroeconomics (CFM).
    6. Eaton, Jonathan & Kortum, Samuel & Neiman, Brent, 2016. "Obstfeld and Rogoff׳s international macro puzzles: a quantitative assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 5-23.
    7. Gong, Liutang & Wang, Chan & Zou, Heng-fu, 2016. "Optimal monetary policy with international trade in intermediate inputs," Journal of International Money and Finance, Elsevier, vol. 65(C), pages 140-165.
    8. Forlati, Chiara, 2015. "On the benefits of a monetary union: Does it pay to be bigger?," Journal of International Economics, Elsevier, vol. 97(2), pages 448-463.
    9. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2018. "Exchange rate misalignment, capital flows, and optimal monetary policy trade-offs," LSE Research Online Documents on Economics 87290, London School of Economics and Political Science, LSE Library.
    10. Chiara Forlati, 2007. "On the Benefits of a Monetary Union: Does it Pay to Be Bigger?," Working Papers 201303, Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne, revised Jul 2012.
    11. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2018. "Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-offs," CEPR Discussion Papers 12850, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    monetary policy; risk sharing; price stability; policy coordination; financial market structure; trade elasticity;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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