IDEAS home Printed from https://ideas.repec.org/p/sce/scecf0/361.html
   My bibliography  Save this paper

Monetary Policy Rules For An Open Economy

Author

Listed:
  • Nicoletta Batini

    (Bank of England)

  • Stephen P. Millard

    (Bank of England, Monetary Analysis)

  • Richard Harrison

    (Bank of England, Monetary Analysis)

Abstract

The most popular simple rules, due to Taylor (1993) and McCallum (1995), are both meant to inform monetary policy in economies that are closed. On the other hand, their main open economy alternative, the Monetary Conditions Index (MCI) rule of Ball (1999) is flawed for a number or reasons, not least because it fails to adequately allow for different types of exchange rate shocks when setting policy. In this paper we derive simple monetary policy rules that are suitable for small open economies in general, and for the UK in particular. We do so by comparing the performance of a battery of complex and simple rules, including the familiar Taylor and McCallum rule and the MCI. The comparison entails stochastically simulating a two-sector open-economy stochastic dynamic general equilibrium model calibrated on UK data. The model displays persistence in the process of domestically generated inflation that arises by assuming 'generalised habit formation' in the preferences for both consumption and leisure.

Suggested Citation

  • Nicoletta Batini & Stephen P. Millard & Richard Harrison, 2000. "Monetary Policy Rules For An Open Economy," Computing in Economics and Finance 2000 361, Society for Computational Economics.
    • Handle: RePEc:sce:scecf0:361
    as

    Download full text from publisher

    File URL: http://fmwww.bc.edu/cef00/papers/paper361.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Nelson, Edward & Nikolov, Kalin, 2003. "UK inflation in the 1970s and 1980s: the role of output gap mismeasurement," Journal of Economics and Business, Elsevier, vol. 55(4), pages 353-370.
    2. Jeffrey C. Fuhrer, 1998. "An Optimising Model for Monetary Policy Analysis: Can Habit Formation Help?," RBA Research Discussion Papers rdp9812, Reserve Bank of Australia.
    3. Svensson, Lars E O & van Wijnbergen, Sweder, 1989. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," Economic Journal, Royal Economic Society, vol. 99(397), pages 785-805, September.
    4. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
    5. Willem H. Buiter & Marcus Miller, 1991. "Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation," NBER Chapters,in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 239-277 National Bureau of Economic Research, Inc.
    6. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters,in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
    7. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters,in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
    8. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, March.
    9. Henderson, Dale W. & McKibbin, Warwick J., 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 221-317, December.
    10. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
    11. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters,in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
    12. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
    13. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
    14. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    15. Alexander L. Wolman, 1999. "Sticky prices, marginal cost, and the behavior of inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 29-48.
    16. Ian Small, 1997. "The cyclicality of Mark-ups and Profit Margins: Some Evidence for Manufacturing and Services," Bank of England working papers 72, Bank of England.
    17. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
    18. Batini, Nicoletta & Nelson, Edward, 2001. "Optimal horizons for inflation targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 891-910, June.
    19. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
    20. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters,in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
    21. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters,in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
    22. Lars Peter Hansen & Thomas J. Sargent, 1993. "Recursive linear models of dynamic economies," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    23. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 765-783.
    24. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    25. Bennett T. McCallum, 2000. "Alternative monetary policy rules : a comparison with historical settings for the United States, the United Kingdom, and Japan," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 49-79.
    26. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
    27. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    28. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters,in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
    29. Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995. "Business cycles in a small open economy," European Economic Review, Elsevier, vol. 39(6), pages 1089-1113, June.
    30. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    31. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
    32. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
    33. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 947-981, July.
    34. Batini, Nicoletta & Harrison, Richard & Millard, Stephen P., 2003. "Monetary policy rules for an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11-12), pages 2059-2094, September.
    35. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
    36. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    37. De Gregorio, Jose & Giovannini, Alberto & Wolf, Holger C., 1994. "International evidence on tradables and nontradables inflation," European Economic Review, Elsevier, vol. 38(6), pages 1225-1244, June.
    38. Ericsson, Neil R & Hendry, David F & Mizon, Grayham E, 1998. "Exogeneity, Cointegration, and Economic Policy Analysis," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(4), pages 370-387, October.
    39. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, March.
    40. Nicoletta Batini & Kenny Turnbull, 2000. "Monetary Conditions Indices for the UK: A Survey," Discussion Papers 01, Monetary Policy Committee Unit, Bank of England.
    41. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters,in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
    42. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
    43. Erik Britton & Jens D J Larsen & Ian Small, 2000. "Imperfect competition and the dynamics of mark-ups," Bank of England working papers 110, Bank of England.
    44. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
    45. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
    46. Simon Hall & Mark Walsh & Anthony Yates, 1997. "How do UK companies set prices?," Bank of England working papers 67, Bank of England.
    47. Kiley, Michael T, 2002. "Partial Adjustment and Staggered Price Setting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 283-298, May.
    48. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
    49. Raf Wouters & Frank Smets, 2000. "Optimal Monetary Policy In An Open Economy," Computing in Economics and Finance 2000 186, Society for Computational Economics.
    50. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
    51. Fabio Ghironi, 2000. "Alternative Monetary Rules for a Small Open Economy: The Case of Canada," Boston College Working Papers in Economics 466, Boston College Department of Economics, revised 30 Oct 2000.
    52. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Closed versus Open Economies: An Integrated Approach," NBER Working Papers 8604, National Bureau of Economic Research, Inc.
    53. Batini, Nicoletta & Nelson, Edward, 2000. "When the Bubble Bursts: Monetary Policy Rules and Foreign Exchange Market Behavior," Working Papers 2000-01, University of Sydney, School of Economics.
    54. Richard H. Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    55. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
    56. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, July.
    57. Devereux, Michael B & Engel, Charles M, 2000. "Monetary Policy In The Open Economy Revisited: Price Setting Rules And Exchange Rate Flexibility," CEPR Discussion Papers 2454, C.E.P.R. Discussion Papers.
    58. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    Full references (including those not matched with items on IDEAS)

    More about this item

    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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sce:scecf0:361. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum). General contact details of provider: http://edirc.repec.org/data/sceeeea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.