Monetary Policy in the Small Open Economy with Market Segmentation

Jae-Hun Shim
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Jae-Hun Shim: University of Bath

No 53/16, Department of Economics Working Papers from University of Bath, Department of Economics

Abstract: We extend a New Keynesian small open economy DSGE model with non-tradable goods and intermediate inputs. Firstly, we show that the optimal monetary policy faces a trade-off between composite domestic inflation and output gap stabilization due to net exports externalities. Secondly, we rank alternative monetary policy rules associated with welfare and show that setting graduate interest rates towards their target levels rather than an immediate response is desirable. However, when the economy is highly exposed to foreign goods market and non-tradable productivity shocks, the CPI-based Taylor rule can be the best alternative policy. Lastly, we identify linkages between final and intermediate sectors and explain “sectoral heterogeneity” under the optimal policy and alternative monetary policy regimes.

Date: 2016-09
New Economics Papers: this item is included in nep-mon and nep-opm
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