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A Welfare Evaluation of East Asian Monetary Policy Regimes under Foreign Output Shock

  • Alba, Joseph D.

    (Nanyang Technological University)

  • Chia, Wai-Mun

    (Nanyang Technological University)

  • Park, Donghyun

    (Asian Development Bank)

Adverse foreign output shocks have a sizable impact on the welfare of small open economies. Therefore, one of the key roles of monetary policy in those economies is to minimize the welfare losses arising from such shocks. To assess the welfare impact of external shocks under different monetary policy regimes, we numerically solve and calculate the welfare loss function of a dynamic stochastic general equilibrium model with complete exchange rate pass through. We find that consumer price index (CPI) inflation targeting minimizes welfare losses for import-to-gross domestic product (GDP) ratios from 0.3 to 0.9. However, welfare under the pegged exchange rate regime is almost equivalent to CPI inflation targeting when the import-to-GDP ratio is 1, while the domestic inflation targeting minimizes welfare when the import-to-GDP ratio is 0.1. We calibrate the model and derive welfare implications for eight East Asian small open economies.

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Paper provided by Asian Development Bank in its series ADB Economics Working Paper Series with number 299.

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Length: 23 pages
Date of creation: 29 Feb 2012
Date of revision:
Handle: RePEc:ris:adbewp:0299
Note: http://www.adb.org/sites/default/files/pub/2012/economics-wp-299.pdf
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