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A Two Sector Small Open Economy Model. Which Inflation to Target?


  • Nooman Rebei
  • Eva Ortega


This paper analyses welfare-improving monetary policy reaction functions in the context of a new-Keynesian small open economy model with a tradables and a non-tradables sector. The model is estimated for the case of Canada and used to evaluate the welfare gains of alternative specifications of the feedback nominal interest rate rule, in particular when allowing for different coefficients on the sectorial inflation rates. We find reasonable estimates for the deep parameters of the model , which include significant heterogeneity in the degree of price rigidity across sectors, as well as reasonable quantitative responses to sectorial and aggregate variables to local and foreign shocks. We find welfare gains in responding somehow more aggressively to aggregate inflation deviations from target than it has been the case in the last three decades and substantial welfare losses if the Bank of Canada aimed at stabilizing output more aggressively. But we find substantial further welfare gains of being more aggressive on imported inflation than on domestic sectors inflation since it is imports prices those that show a higher level of estimated stickiness

Suggested Citation

  • Nooman Rebei & Eva Ortega, 2005. "A Two Sector Small Open Economy Model. Which Inflation to Target?," Computing in Economics and Finance 2005 298, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:298

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    Cited by:

    1. Cambell Leith & Simon Wren-Lewis, 2006. " The Optimal Monetary Policy Response to Exchange Rate Misalignments," CDMA Conference Paper Series 0605, Centre for Dynamic Macroeconomic Analysis.

    More about this item

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook


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