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Monetary policy rules in the open economy: effects of welfare and business cycles

  • Robert Kollmann

This Paper computes welfare maximizing Taylor-style interest rate rules, in a business cycle model of a small open economy. The model assumes staggered price setting and shocks to domestic productivity, to the world interest rate, to world inflation and to the uncovered interest rate parity condition. Optimized policy rules have a pronounced anti-inflation stance and entail significant nominal and real exchange rate volatility. The country responds to an increase in external volatility by holding more foreign assets. The policy rule affects the variance and the mean of consumption. The effect on the mean matters significantly for welfare.

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Paper provided by ULB -- Universite Libre de Bruxelles in its series ULB Institutional Repository with number 2013/7628.

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Date of creation: 2002
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Publication status: Published in: Journal of Monetary Economics (2002) v.49,p.989-1015
Handle: RePEc:ulb:ulbeco:2013/7628
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