Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles

28 Pages Posted: 19 Apr 2002

See all articles by Robert Kollmann

Robert Kollmann

ECARES, Université Libre de Bruxelles; University of Paris XII - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: March 2002

Abstract

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.

Keywords: Open economy, interest rate rules, business cycles

JEL Classification: E40, F30, F40

Suggested Citation

Kollmann, Robert, Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles (March 2002). Available at SSRN: https://ssrn.com/abstract=308059

Robert Kollmann (Contact Author)

ECARES, Université Libre de Bruxelles ( email )

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University of Paris XII - Department of Economics ( email )

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France

HOME PAGE: http://www.robertkollmann.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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