DP9087 Is Monetary Policy in an Open Economy Fundamentally Different?

Author(s): Tommaso Monacelli
Publication Date: August 2012
Keyword(s): consumption imports, exchange rate, imported inputs, monetary policy, openness, trade
JEL(s): E52, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9087

Openness per se requires optimal monetary policy to deviate from the canonical closed-economy principle of domestic price stability, even if domestic prices are the only ones to be sticky. I review this argument using a simple partial equilibrium analysis in an economy that trades in final consumption goods. I then extend the standard open economy New Keynesian model to include imported inputs of production. Production openness strengthens even further the incentive for the policymaker to deviate from strict domestic price stability. With both consumption and production openness variations in the world price of food and in the world price of imported oil act as exogenous cost-push factors.