De Paoli, Bianca
Monetary policy and welfare in a small open economy.
Centre for Economic Performance, London School of Economics and Political Science, London, UK.
This paper characterizes welfare in a small open economy and derives the corresponding optimal monetary policy rule. It shows that the utility-based loss function for a small open economy is a quadratic expression in domestic inflation, output gap and real exchange rate. In contrast to previous works, this paper demonstrates that welfare in a small open economy, completely integrated with the rest of the world, is affected by exchange rate variability. Consequently, the optimal policy in a small open economy is not isomorphic to a closed economy and does not prescribe a pure floating exchange rate regime. Domestic inflation targeting is optimal only under a particular parameterization, where the unique relevant distortion in the economy is price stickiness. Under a general specification for preferences and in the presence of inefficient steady state output, exchange rate targeting arises as part of the optimal monetary plan.
||© 2004 Bianca De Paoli
||Welfare, Optimal Monetary Policy, Small Open Economy
|Library of Congress subject classification:
||H Social Sciences > HV Social pathology. Social and public welfare. Criminology
H Social Sciences > HJ Public Finance
|Journal of Economic Literature Classification System:
||E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects)
||Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Departments > Economics
||25 Jul 2008 09:48
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