monetary policy rules in the open economy effects on welfare and business cycles 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

nominal income targeting in an open economy optimizing model abstract this paper presents simulation results regarding the performance of nominal income targeting a monetary policy rule that sets interest rates in response to deviations of nominal gdp growth from a target path the macroeconomic model is one in which agents solve dynamic optimization problems with rational expectations but in an environment with slow price adjustments in the present version consumption choices reflect habit formation and the economy is open to international flows of goods and securities when calibrated to quarterly us data the model s results suggest that nominal income targeting performs well in relation to inflation targeting and taylor rules

optimal monetary policy responses to relative price changes abstract an optimizing model with a flexible price sector and a sticky price sector is presented to analyze the effects of relative price changes on inflation fluctuations the relative price of the flexible price good represents a shift parameter of the new keynesian phillips curve the optimal monetary policy is to target sticky price inflation rather than a broad inflation measure although stabilizing the relative price around its efficient value is one of the appropriate goals of the central bank stabilizing sticky price inflation is sufficient for achieving this goal an optimal monetary policy for a small open economy is also discussed

can monetizing trade lower welfare an example abstract in decentralized trade individuals self insure against consumption risk via costly diversification of skills although money acts as consumption insurance it may lead to a moral hazard problem if the problem is severe monetizing trade can lower welfare relative to barter

stabilization policy and the costs of dollarization this paper compares the welfare costs of business cycles in a dollarized economy to those associated with several alternative monetary regimes belonging to three broad families interest rate feedback rules inflation targeting and money growth rate rules the analysis is conducted within an optimizing model of a small open economy with sticky prices the model is calibrated to the mexican economy and is driven by 3external shocks terms of trade world interest rate and import price inflation we show econometrically that these shocks explain more than 75 of the observed forecasting error variance of mexican output and the mexican real exchange rate at 4 to 16 quarter horizons the welfare comparisons suggest that dollarization is the least successful of the monetary policy rules considered agents are willing to give up more than 2 of their non stochastic steady state consumption to see a policy other than dollarization implemented

nominal price rigidity money supply endogeneity and business cycles abstract this paper investigates the ability of nominal price rigidity to explain the co movement of inflation with the cyclical component of output observed in the post war u s data a dynamic general equilibrium model is constructed with the introduction of monopolistic competition and nominal price rigidity in a standard real business cycle model allowing for an endogenous money supply rule it is then demonstrated that sticky price models can explain the observed associations between movements in inflation and output much better than flexible price models this result depends little on whether money supply is assumed to be endogenous or not

optimal monetary policy in open versus closed economies an integrated approach in clarida et al 1999 hereafter cgg we presented a normative analysis of monetary policy within a simple optimization based closedeconomy framework we derived the optimal policy rule and among other things characterized the gains from commitment also we made precise the implications for the kind of instrument feedback rule that a central bank should follow in practice in this paper we show how our analysis extends to the case of a small open economy openness complicates the problem of monetary management to the extent the central bank must take into account the impact of the exchange rate on real activity and inflation how to factor the exchange rate into the overall design of monetary policy accordingly becomes a central consideration here we show that under certain conditions the monetary policy design problem for the small open economy is isomorphic to the problem of the closed economy that we considered earlier hence all our qualitative results for the closed economy carry over to this case openness does affect the parameters of the model suggesting quantitative implications though the general form of the optimal interest rate feedback rule remains the same as in the closedeconomy case for example how aggressively a central bank should adjust the interest rate in response to inflationary pressures depends on the degree of openness in addition openness gives rise to an important distinction between domestic inflation and consumer price inflation as defined by the cpi to the extent that there is perfect exchange rate pass through we find that the central bank should target domestic inflation and allow the exchange rate to float despite the impact of the resulting exchangerate variability on the cpi kosuki aoki 1999 gali and tommaso monacelli 2000

new directions for stochastic open economy models the paper develops a simple stochastic new open economy macroeconomic model based on sticky nominal wages explicit solution of the wage setting problem under uncertainty allows one to analyze the effects of the monetary regime on welfare expected output and the expected terms of trade despite the potential interplay between imperfections due to sticky wages and monopoly the optimal monetary policy rule has a closed form solution to motivate our model we show that observed correlations between terms of trade and exchange rates are more consistent with our traditional assumptions about nominal rigidities than with a popular alternative based on local currency pricing 2000 elsevier science b v all rights reserved

international business cycles the authors estimate a dynamic two country model in which economic fluctuations are driven by a worldwide supply shock country specific supply shocks and relative fiscal money and preference shocks identification is achieved using only long run restrictions based on a theoretical model the main results are 1 supply shocks particularly country specific ones are very important in generating international business cycles and 2 although the post 1973 flexible exchange rate period has been inherently more volatile there are no differences in transmission properties of economic disturbances across exchange rate regimes for the endogenous variables they focus on copyright 1993 by american economic association

monetary policy rules for an open economy the most popular simple rule for the interest rate due to taylor 1993a is meant to inform monetary policy in economies that are closed on the other hand its main open economy alternative i e ball s 1999 rule based on a monetary conditions index mci may perform poorly in the face of specific types of exchange rate shocks and thus cannot offer guidance for the day to day conduct of monetary policy in this paper we specify and evaluate a comprehensive set of simple monetary policy rules that are suitable for small open economies in general and for the united kingdom in particular we do so by examining the performance of a battery of simple rules including the familiar taylor rule and mci based rules a la ball this entails comparing the asymptotic properties of a two sector open economy dynamic stochastic general equilibrium model calibrated on united kingdom data under different rules we find that an inflation forecast based rule ifb i e a rule that reacts to deviations of expected inflation from target is a good simple rule in this respect when the horizon is adequately chosen adding a separate response to the level of the real exchange rate contemporaneous and lagged appears to reduce the difference in adjustment between output gaps in the two sectors of the economy but the improvement is only marginal importantly an ifb rule with or without exchange rate adjustment appears robust to different shocks in contrast to naive or ball s mci based rules

the exchange rate in a dynamic optimizing business cycle model with nominal rigidities a quantitative investigation this paper studies a quantitative dynamic optimizing business cycle model of a small open economy with staggered price and wage setting the model exhibits exchange rate overshooting in response to money supply shocks the predicted variability of the nominal and especially of the real exchange rate is noticeably higher than in standard real business cycle models with flexible prices and wages a positive domestic money supply shock is predicted to lower the domestic interest rate raise gdp and trigger a depreciation of both the nominal and real exchange rate increases in domestic productivity and in the world interest rate are also predicted to induce a nominal and real exchange rate depreciation 2001 elsevier science b v all rights reserved

exchange rate systems and macroeconomic stability abstract we examine macroeconomic stability and the properties of the international transmission of business cycles under three exchange rate systems a flexible a unilateral peg ems and a single currency emu the subjects of study are germany and france in france macroeconomic volatility under emu is comparable to that under a flexible exchange rate system but considerably lower than that under ems in germany output volatility is significantly higher under ems relative to the flexible regime and increases even further under emu inflation though becomes more stable emu also induces a strong negative international transmission of country specific supply shocks and amplifies their role this fact may complicate ecb policymaking

austrian and swedish social democrats in crisis party strategy and organization in corporatist regimes socialists and social democrats have probably nowhere been better entrenched than in austria and sweden yet in both countries they have suffered electoral defeats in the 1980s and early 1990s ju

business cycles and the exchange rate system some international evidence this paper investigates the differences in time series behavior of key economic aggregates under alternative exchange rate systems we use a postwar sample of 49 countries to compare the behavior of output consumption trade flows government consumption spending and real exchange rates under alternative exchange rate systems pegged floating and cooperative systems such as the ems we then examine evidence from two particular episodes involving canada and ireland of changes in the exchange rate system aside from greater variability of real exchange rates under flexible than under pegged nominal exchange rate systems we find little evidence of systematic differences in the behavior of macroeconomic aggregates or international trade flows under alternative exchange rate systems these results are of interest because a large class of theoretical models implies that the nominal exchange rate system has important effects on a number of macroeconomic quantities

consumption real exchange rates and the structure of international asset markets abstract international real business cycle irbc models that assume complete asset markets yield strong restrictions for consumption and bilateral real exchange rate series empirical tests with data for the us japan france uk italy canada and sweden suggest that neither the trend behavior nor high frequency movements of consumption and real exchange rates are well explained by irbc models with complete markets it appears however that high frequency fluctuations of consumption and real exchange rates are consistent with unrestricted international trade in risk free bonds

monetary models of dollar yen euro nominal exchange rates dead or undead the predictions of the models were based on ex post realised values of the explanatory variables in other words the standard exchange rate models we estimated exhibited extremely poor out of sample fit 2 at the time these nihilistic results seemed quite radical since there was widespread optimism about the potential of monetary models especially sticky price monetary models to explain how flexible exchange rates function after all the main cornerstones of monetary exchange rate models were relatively noncontroversial long run purchasing power parity or some variant of ppp and a presumption that there is a strong long run connection between money growth and inflation today the meese and rogoff 1983a results no longer seem quite so crazy despite longer data sets on modern floating rates and the application of more sophisticated econometric techniques researchers have continued to find it very frustrating to firmly demonstrate any systematic relationship between exchange rates and macroeconomic fundamentals at least for the cross rates between the dollar dm euro and yen it is true that researchers have occasionally found particular sub samples where certain models seem to perform noticeably better than the random walk model but as a rule these results wilt under sustained out of sample testing surveying the evidence in their survey for the handbook of international economics frankel and rose 1995 conclude that numerous attempts to overturn the meese and rogoff 1983a results have failed

the new open economy macroeconomics a survey since the 1995 publication of obsteld and rogoff s redux model there has been an outpouring of research on open economy dynamic general equilibrium models that incorporate imperfect competition and nominal rigidities this paper offers an interim survey of this recent literature 2001 elsevier science b v all rights reserved

does exchange rate stability increase trade and welfare we develop a simple general equilibrium framework to study the effect of the exchange rate system on trade and welfare an important feature of the model is deviations from purchasing power parity caused by rigid price setting in buyers currency we find the following first exchange rate stability is not necessarily associated with more trade in a simple benchmark model with separable preferences and only monetary shocks trade is unaffected by the exchange rate system consistent with most evidence second both trade and welfare can be higher under either exchange rate system depending on preferences and on the monetary policy rules followed under each system finally in general there is no one to one relationship between the levels of trade and welfare across exchange rate systems

the role of countercyclical monetary policy when firms set nominal prices in advance optimal monetary policy insulates aggregate output against shocks to demand it can do so however by following the constant money growth rule advocated by milton friedman it need not respond to the shocks in an actively countercyclical way in addition to the extent that output fluctuations are driven by shocks to supply money growth should be procyclical

international comparisons of pricing to market behavior this paper measures the degree of price discrimination across export destinations that is associated with exchange rate changes using u s u k german and japanese industry level data given the industries sampled more price discrimination across destinations is observed in the u k german and japanese data for industries that match across source countries however behavior is very similar across source countries furthermore destination specific price adjustment on exports to the united states from germany and japan is similar to price adjustment observed on shipments to other destinations most variation in the data appears to be related to industry copyright 1993 by american economic association