International Dimensions of Optimal Monetary Policy

45 Pages Posted: 8 Apr 2001 Last revised: 21 Oct 2010

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; 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)

Multiple version iconThere are 3 versions of this paper

Date Written: April 2001

Abstract

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.

Suggested Citation

Corsetti, Giancarlo and Pesenti, Paolo A., International Dimensions of Optimal Monetary Policy (April 2001). NBER Working Paper No. w8230. Available at SSRN: https://ssrn.com/abstract=266200

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

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Rome, 00154
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Centre for Economic Policy Research (CEPR)

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Paolo A. Pesenti

Federal Reserve Bank of New York ( email )

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212-720-6831 (Fax)

National Bureau of Economic Research (NBER)

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