Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices

39 Pages Posted: 17 Apr 2001

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Edward Nelson

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: April 2001

Abstract

The "new open-economy macroeconomics" seeks to provide an improved basis for monetary and exchange-rate policy through the construction of open-economy models that feature rational expectations, optimizing agents, and slowly adjusting prices of goods. This Paper promotes an alternative approach for constructing such models by treating imports not as finished consumer goods but rather as raw-material inputs to the home economy's productive process. This treatment leads to a clean and simple theoretical structure that has some empirical attractions as well. A particular small-economy model is calibrated and its properties exhibited, primarily by means of impulse response functions. The preferred variant is shown to feature a pattern of correlations between exchange-rate changes and inflation that is more realistic than provided by a more standard specification. Important recent events are interpreted in light of the alternative models.

Keywords: Exchange rates and inflation, monetary policy rules, new open economy macroeconomics

JEL Classification: E52, E58, F41

Suggested Citation

McCallum, Bennett T. and Nelson, Edward, Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices (April 2001). CEPR Discussion Paper No. 2756, Available at SSRN: https://ssrn.com/abstract=267152

Bennett T. McCallum (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

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National Bureau of Economic Research (NBER)

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Edward Nelson

Board of Governors of the Federal Reserve System ( email )

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