International Dimensions of Optimal Monetary Policy

45 Pages Posted: 9 Aug 2006

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS); University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Paolo A. Pesenti

Federal Reserve Bank of New York; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: April 2001

Abstract

This paper provides a baseline general-equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms that set prices one period in advance. Strict adherence to inward-looking policy objectives such as the stabilization of domestic output cannot be optimal when firms' markups are exposed to currency fluctuations. Such policies induce excessive volatility in exchange rates and foreign sales revenue, leading exporters to set higher prices in response to higher profit risk. In general, optimal rules trade off a larger domestic output gap against lower import prices. Monetary rules in a world Nash equilibrium lead to less exchange rate volatility relative to both inward-looking rules and discretionary policies, even when the latter do not suffer from any inflationary (or deflationary) bias. Gains from international monetary cooperation are related in an nonmonotonic way to the degree of exchange rate pass-through.

Keywords: optimal cyclical monetary policy, nominal rigidities, exchange rate pass-through, international cooperation

JEL Classification: E31, E52, F42

Suggested Citation

Corsetti, Giancarlo and Pesenti, Paolo A., International Dimensions of Optimal Monetary Policy (April 2001). FRB of New York Staff Report No. 124. Available at SSRN: https://ssrn.com/abstract=923375 or http://dx.doi.org/10.2139/ssrn.923375

Giancarlo Corsetti

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

Villa La Fonte, via delle Fontanelle 18
50016 San Domenico di Fiesole
Florence, Florence 50014
Italy

University of Rome III - Department of Economics ( email )

via Ostiense, 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Paolo A. Pesenti (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5493 (Phone)
212-720-6831 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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