Citation

Discussion Paper Details

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Title: International Dimensions of Optimal Monetary Policy

Author(s): Giancarlo Corsetti and Paolo Pesenti

Publication Date: April 2002

Keyword(s): exchange rate pass-through, international cooperation, nominal rigidities and optimal yclical monetary policy

Programme Area(s): International Macroeconomics

Abstract: This Paper provides a baseline general-equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms and nominal rigidities. An inward-looking policy of complete domestic output stabilization is not optimal when firms' markups are exposed to currency fluctuations. Such policy raises exchange rate volatility, leading foreign exporters to charge higher prices vis-a-vis the increased uncertainty in the export market. As higher import prices reduce the purchasing power of domestic consumers, optimal monetary rules trade off a larger domestic output gap against lower consumer prices. Optimal 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 a non-monotonic way to the degree of exchange rate pass-through.

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Bibliographic Reference

Corsetti, G and Pesenti, P. 2002. 'International Dimensions of Optimal Monetary Policy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3349