|This centre is a member of The LSE Research Laboratory [RLAB]: CASE | CVER | CEP | SERC | STICERD||Cookies?|
Paper No' CEPDP0639: | Full paper
Save Reference as: BibTeX File | EndNote Import File
Keywords: Welfare; Optimal Monetary Policy, Small Open Economy
JEL Classification: F41; E52; E58; E61
Is hard copy/paper copy available? YES - Paper Copy Still In Print.
This Paper is published under the following series: CEP Discussion Papers
Share this page: Google Bookmarks | Facebook | Twitter
Abstract: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.
Copyright © RLAB & LSE 2003 - 2018 | LSE, Houghton Street, London WC2A 2AE | Contact: RLAB | Site updated 23 February 2018