Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles
ECARES, Université Libre de Bruxelles; University of Paris XII - Department of Economics; Centre for Economic Policy Research (CEPR)
February 7, 2002
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.
Number of Pages in PDF File: 30
Keywords: Keywords: Open economy; Interest rate rules; Welfare; Business Cycles
JEL Classification: E4; F3; F4working papers series
Date posted: March 13, 2003
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