Optimal monetary policy in open economies revisited

Ippei Fujiwara, Jiao Wang

    Research output: Contribution to journalArticle

    Abstract

    This paper revisits optimal monetary policy in open economies, in particular, focusing on the noncooperative policy game under local currency pricing in a two-country dynamic stochastic general equilibrium model. We first derive the quadratic loss functions which noncooperative policy makers aim to minimize. Then, we show that noncooperative policy makers face extra trade-offs regarding stabilizing real marginal costs induced by deviations from the law of one price under local currency pricing, and that optimal monetary policy seeks to stabilize CPI inflation rates and more so under noncooperation than it does under cooperation. As a result of the increased number of stabilizing objectives, welfare gains from cooperation emerge even when two countries face only technology shocks. Still, gains from cooperation are not large, implying that frictions other than nominal rigidities are necessary to strongly recommend cooperation as an important policy framework to increase global welfare
    Original languageEnglish
    Pages (from-to)300-314
    JournalJournal of International Economics
    Volume108
    DOIs
    Publication statusPublished - 2017

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