DP425 When Does Coordination Pay?

Author(s): Marcus Miller, Mark Salmon
Publication Date: July 1990
Keyword(s): Certainty Equivalence, Floating Exchange Rates, Policy Coordination, Time Consistency
JEL(s): 133, 134, 325
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=425

In a continuous time model of two symmetric open economies, with a floating exchange rate, we find that the pay-off to the policy coordination depends systematically on the heterogeneity of their inflation experience. While monetary policy coordination improves welfare when there is a common rate of underlying inflation, it exacerbates the `time-consistency' problem arising when there are differences. Since the principle of `certainty equivalence' applies to time-consistent policy in linear quadratic models, we are also able to give a stochastic interpretation of the deterministic results.