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Optimal Monetary Policy in an Open Economy under Asset Market Segmentation

  • Rajesh Singh

    (Iowa State University)

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    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.

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    File URL: https://www.economicdynamics.org/meetpapers/2013/paper_103.pdf
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    Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 103.

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    Date of creation: 2013
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    Handle: RePEc:red:sed013:103
    Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
    Fax: 1-314-444-8731
    Web page: http://www.EconomicDynamics.org/society.htm
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    1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 2002. "A Simple Framework for International Monetary Policy Analysis," CEPR Discussion Papers 3355, C.E.P.R. Discussion Papers.
    2. Julio J. Rotemberg, 1982. "A Monetary Equilibrium Model with Transactions Costs," NBER Working Papers 0978, National Bureau of Economic Research, Inc.
    3. Singh, Rajesh & Lahiri, Amartya & Vegh, Carlos A, 2007. "Segmented Asset Markets and Optimal Exchange Rate Regimes," Staff General Research Papers 11446, Iowa State University, Department of Economics.
    4. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
    5. Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "Stabilization Policy and the Costs of Dollarization," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 482-509, May.
    6. Fernando Alvarez & Andrew Atkeson, 1996. "Money and Exchange Rates in the Grossman-Weiss-Rotemberg Model," NBER Working Papers 5678, National Bureau of Economic Research, Inc.
    7. Chatterjee, S. & Corbae, D., 1990. "Endogenous Market Participation and the General Equelibrium Value of Money," Working Papers 90-30a, University of Iowa, Department of Economics.
    8. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
    9. Casey B. Mulligan & Xavier Sala-i-Martin, 2000. "Extensive Margins and the Demand for Money at Low Interest Rates," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 961-991, October.
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