Welfare-Based Optimal Monetary Policy in a Two-Sector Small Open Economy

Yuliya Rychalovska

Working Papers from Czech National Bank, Research and Statistics Department

Abstract: The paper analyzes the stabilization objectives of optimal monetary policy and the trade-offs facing the central bank in a two-sector small open economy model obtained as a limiting case of a two-country DSGE framework. We introduce a more complicated economic structure, namely, multiple domestic sectors combined with a variety of exogenous shocks. In addition, our model includes a more general specication of consumers’ preferences than has been considered in the literature so far. As a result, we are able to uncover additional welfare effects specic to the open multi-sectoral economy and make a methodological contribution by deriving a utility-based welfare measure and the optimal reaction function of the central bank. We show that the optimal targeting rule is represented by a complex expression that prescribes the response to the appropriate measure of domestic inflation, sectoral output gaps, as well as to the relevant relative prices. We demonstrate that our model generates an endogenous conflict between the objectives of domestic inflation and real exchange rate stabilization in addition to the inflation-output gap policy trade-off common in the literature. Furthermore, we experiment with alternative simple rules and analyze their ability to replicate the optimal solution.

Keywords: DSGE models; non-traded goods; optimal monetary policy; welfare. (search for similar items in EconPapers)
JEL-codes: E52 E58 E61 F41 (search for similar items in EconPapers)
Date: 2007-12
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.cnb.cz/export/sites/cnb/en/economic-re ... wp/cnbwp_2007_16.pdf

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cnb:wpaper:2007/16

Access Statistics for this paper

More papers in Working Papers from Czech National Bank, Research and Statistics Department Contact information at EDIRC.
Bibliographic data for series maintained by Tomas Karhanek ().