International Dimensions of Optimal Monetary Policy
European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS); University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)
Paolo A. Pesenti
Federal Reserve Bank of New York; National Bureau of Economic Research (NBER)
NBER Working Paper No. w8230
This paper provides a baseline general-equilibrium model of optimal monetary policy among interdependent economies, with monopolistic firms that set prices one period in advance. Strict adherence to inward-looking policy objectives such as the stabilization of domestic output cannot be optimal when firms' markups are exposed to currency fluctuations. Such policies induce excessive volatility in exchange rates and foreign sales revenue, leading exporters to set higher prices in response to higher profit risk. In general, optimal rules trade off a larger domestic output gap against lower import prices. Monetary rules in a world Nash equilibrium lead to smaller 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.
Number of Pages in PDF File: 45working papers series
Date posted: April 8, 2001
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