International Dimensions of Optimal Monetary Policy
Journal of Monetary Economics, 2005, 52, 2, 281-305
CORSETTI, Giancarlo, PESENTI, Paolo, International Dimensions of Optimal Monetary Policy, Journal of Monetary Economics, 2005, 52, 2, 281-305 - http://hdl.handle.net/1814/6681
Retrieved from Cadmus, EUI Research Repository
This paper provides a baseline general equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms and nominal rigidities. An inward-looking policy of domestic price stabilization is not optimal when firms’ markups are exposed to currency fluctuations. Such a policy raises exchange rate volatility, leading foreign exporters to charge higher prices vis-à-vis increased uncertainty in the export market. As higher import prices reduce the purchasing power of domestic consumers, optimal monetary rules trade off a larger domestic output gap against lower consumer prices. Optimal rules in a world Nash equilibrium lead to less exchange rate volatility relative to both inward-looking rules and discretionary policies, even when the latter do not suffer from any inflationary (or deflationary) bias. Gains from international monetary cooperation are related in a non-monotonic way to the degree of exchange rate pass-through.
Cadmus permanent link: http://hdl.handle.net/1814/6681
Full-text via DOI: 10.1016/j.jmoneco.2004.06.002
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