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Monetary Rules for Commodity Traders

  • Luis Catão
  • Roberto Chang

We develop a dynamic model of a small open economy that trades commodities whose world prices are subject to realistic random fluctuations, and study the implications of monetary policy alternatives. The model is much more flexible than those of previous studies, especially in allowing to compare perfect risk sharing against financial autarky. In each case we show how to derive analytically optimal Ramsey allocations and flexible price allocations, and hence to examine the crucial role of behavioral elasticities, production structure, and capital mobility in determining the welfare properties of different monetary choices. Applying these insights to a calibrated example, we find that the impulse responses associated with PPI targeting track flexible price allocations closely, but can diverge greatly from the Ramsey allocations, especially when risk sharing is perfect and the elasticity of demand for exports of a home aggregate is high. In those cases, policies that stabilize the real exchange rate more than PPI targeting, such as targeting expected inflation, deliver higher welfare. But PPI targeting is the clear winner under portfolio autarky.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18536.

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Date of creation: Nov 2012
Date of revision:
Publication status: published as Luis Cat�o & Roberto Chang, 2013. "Monetary Rules for Commodity Traders," IMF Economic Review, Palgrave Macmillan, vol. 61(1), pages 52-91, April.
Handle: RePEc:nbr:nberwo:18536
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  1. Jordi Gali & Tommaso Monacelli, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," NBER Working Papers 8905, National Bureau of Economic Research, Inc.
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