Ramsey Monetary Policy and International Relative Prices

57 Pages Posted: 9 Jun 2004

See all articles by Tommaso Monacelli

Tommaso Monacelli

Bocconi University - Department of Economics

Ester Faia

Goethe University Frankfurt; Kiel Institute for the World Economy; University of Angers - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2004

Abstract

We analyze optimal monetary policy in a two-country model with price stickiness and imperfect competition. In this context, a terms of trade externality affects policy interaction between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by considering all the distortions relevant to the Ramsey planner. This strategy entails two main advantages. First, it allows an accurate characterization of optimal policy in an economy that evolves around a steady-state which is not necessarily efficient. Second, it allows to describe a range of alternative equilibria when price setters in both countries are forward- looking and households' preferences are unrestricted. We study optimal policy both in the long-run and along a dynamic path, and we compare optimal commitment policy under Nash competition and under cooperation. By deriving a second order accurate solution to the policy functions, we also characterize the welfare gains from international policy cooperation.

Keywords: optimal monetary policy, Ramsey planner, Nash equilibrium, cooperation, sticky prices, imperfect competition

JEL Classification: E52, F41

Suggested Citation

Monacelli, Tommaso and Faia, Ester, Ramsey Monetary Policy and International Relative Prices (April 2004). ECB Working Paper No. 344; IGIER Working Paper No. 254. Available at SSRN: https://ssrn.com/abstract=500722

Tommaso Monacelli (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Ester Faia

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Kiel Institute for the World Economy

P.O. Box 4309
Kiel, D-24100
Germany

University of Angers - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP)

Ecole Normale Superieure
48 boulevard Jourdan
75014 Paris
France

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