DP4012 Monetary Policy Rules in an Interdependent World

Author(s):	Robert Kollmann
Publication Date:	August 2003
Keyword(s):	business cycles, exchange rate regime, interest rate parity
JEL(s):	E40, F30, F40
Programme Areas:	International Macroeconomics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=4012

This Paper analyses the welfare effects of monetary policy rules in a quantitative business cycle model of a two-country world. The model features staggered price setting, and shocks to productivity and to the uncovered interest rate parity (UIP) condition. UIP shocks have a sizable negative effect on welfare, when trade links are strong. An exchange rate peg may raise world welfare, if the peg eliminates the UIP shocks. The model explains the empirical finding that more open economies are more likely to adopt a peg.