Optimal Monetary Policy in Open Economies Revisited

74 Pages Posted: 9 May 2016

See all articles by Ippei Fujiwara

Ippei Fujiwara

Australian National University (ANU) - Crawford School of Public Policy

Jiao Wang

Australian National University (ANU)

Date Written: 2016-05-01

Abstract

This paper revisits optimal monetary policy in open economies, in particular, focusing on the noncooperative policy game under local currency pricing in a two-country dynamic stochastic general equilibrium model. We first derive the quadratic loss functions which noncooperative policy makers aim to minimize. Then, we show that noncooperative policy makers face extra trade-offs regarding stabilizing the real marginal costs induced by deviations from the law of one price under local currency pricing. As a result of the increased number of stabilizing objectives, welfare gains from cooperation emerge even when two countries face only technology shocks, which usually leads to equivalence between cooperation and noncooperation. Still, gains from cooperation are not large, implying that frictions other than nominal rigidities are necessary to strongly recommend cooperation as an important policy framework to increase global welfare.

JEL Classification: E52, F41, F42

Suggested Citation

Fujiwara, Ippei and Wang, Jiao, Optimal Monetary Policy in Open Economies Revisited (2016-05-01). Globalization and Monetary Policy Institute Working Paper No. 272, Available at SSRN: https://ssrn.com/abstract=2776938 or http://dx.doi.org/10.24149/gwp272

Ippei Fujiwara (Contact Author)

Australian National University (ANU) - Crawford School of Public Policy ( email )

ANU College of Asia and the Pacific
J.G. Crawford Building #132 Lennox Crossing
Canberra, Australian Capital Territory 0200
Australia

Jiao Wang

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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