Ramsey Monetary Policy and International Relative Prices

45 Pages Posted: 11 Jun 2004

See all articles by Ester Faia

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)

Tommaso Monacelli

Bocconi University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: May 2004

Abstract

We analyse welfare-maximizing monetary policy in a dynamic general equilibrium two-country model with price stickiness and imperfect competition. In this context, a typical terms of trade externality affects policy interaction between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by an explicit consideration of all the distortions that are 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 that is not necessarily efficient. Second, it allows us to describe a full range of alternative dynamic equilibria when price-setters in both countries are completely forward-looking and households' preferences are not restricted. We study optimal policy both in the long run and in response to shocks, and we compare commitment 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

Faia, Ester and Monacelli, Tommaso, Ramsey Monetary Policy and International Relative Prices (May 2004). CEPR Discussion Paper No. 4386. Available at SSRN: https://ssrn.com/abstract=556120

Ester Faia (Contact Author)

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

Tommaso Monacelli

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

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