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Monetary policy and welfare in a small open economy

De Paoli, Bianca (2009) Monetary policy and welfare in a small open economy. Journal of International Economics, 77 (1). pp. 11-22. ISSN 0022-1996

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Identification Number: 10.1016/j.jinteco.2008.09.007


This paper analyzes optimal monetary policy in a small open economy featuring monopolistic competition and nominal rigidities. It shows that the utility-based loss function for this economy can be written as a quadratic expression of domestic inflation, output gap and real exchange rate. The presence of an internal monopolistic distortion and a terms of trade externality drives optimal policy away from domestic inflation targeting and affects the optimal level of exchange rate volatility. When domestic and foreign goods are close substitutes for each other, the optimal policy rule implies lower real exchange rate volatility than a domestic inflation targeting regime. The reverse is true when the elasticity of substitution between goods is low.

Item Type: Article
Official URL:
Additional Information: © 2009 Elsevier
Divisions: Economics
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HJ Public Finance
Date Deposited: 06 Apr 2011 15:09
Last Modified: 03 Apr 2024 04:51

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