Price Stability with Imperfect Financial Integration

Pierpaolo Benigno

No 2854, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This Paper evaluates the welfare implications of policy rules when international financial markets are incomplete. Using a two-country dynamic general equilibrium model with incomplete markets, price stickiness and monopolistic competition, one finds that an allocation in which the producer inflation rates in both countries are stabilized to zero reproduces the flexible-price allocation. This allocation, however, is sub-optimal with deadweight losses evaluated at around 0.05 percent of a permanent shift in steady-state consumption. A state-contingent producer inflation policy is the feasible first-best. The gains from pursuing this policy instead of price stability are, however, small in terms of reduction in the deadweight losses. Therefore, under incomplete markets, price stability is a good approximation of the feasible first best policy.

Keywords: incomplete markets; optimal monetary policy; price stability (search for similar items in EconPapers)
JEL-codes: E58 F41 (search for similar items in EconPapers)
Date: 2001-06
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Journal Article: Price stability with imperfect financial integration (2008)
Journal Article: Price Stability with Imperfect Financial Integration (2009)
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