Ramsey Monetary Policy and International Relative Prices
57 Pages Posted: 9 Jun 2004
Date Written: April 2004
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
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