DP3355 A Simple Framework for International Monetary Policy Analysis

Author(s): Richard Clarida, Jordi Galí, Mark Gertler
Publication Date: April 2002
Keyword(s): co-operation, international monetary policy, marginal cost, nash equilibrium
JEL(s): E50, F30
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3355

We study the international monetary policy design problem within an optimizing two-country sticky price model, where each country faces a short run trade-off between output and inflation. The model is sufficiently tractable to solve analytically. We find that in the Nash equilibrium, the policy problem for each central bank is isomorphic to the one it would face if it were a closed economy. Gains from co-operation arise, however, that stem from the impact of foreign economic activity on the domestic marginal cost of production. While under Nash central banks need only adjust the interest rate in response to domestic inflation, under co-operation they should respond to foreign inflation as well. In either scenario, flexible exchange rates are desirable.