Caution or Activism? Monetary Policy Strategies in an Open Economy

Lucio Sarno, Martin Ellison and Jouko Vilmunen

No 4766, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We examine optimal policy in a two-country model with uncertainty and learning, where monetary policy actions affect the real economy through the real exchange rate channel. Our results show that whether policy should be cautious or activist depends on the size of one country relative to another. If one country is small relative to the other then activism is optimal. In contrast, if the two countries are equal sized then caution prevails. Caution is induced in the latter case because of the interaction between the home and foreign central banks. In a two-country symmetric equilibrium, learning is shown to be detrimental to welfare, implying that optimal policy is cautious.

Keywords: Monetary policy; Open economy; Learning (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Date: 2004-11
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
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Citations: View citations in EconPapers (5)

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Related works:
Journal Article: CAUTION OR ACTIVISM? MONETARY POLICY STRATEGIES IN AN OPEN ECONOMY (2007)
Working Paper: Caution or Activism? Monetary Policy Strategies in an Open Economy (2007)
Working Paper: Caution or Activism? Monetary Policy Strategies in an Open Economy (2006)
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