Optimal Choice of Monetary Policy Instruments in a Small Open Economy

Rajesh Singh () and Chetan Subramanian

Staff General Research Papers from Iowa State University, Department of Economics

Abstract: This paper studies how the nature of shocks affects the optimal choice of monetary policy instruments in a small open economy. Three classic rules, fixed exchange rates, monetary targeting, and inflation targeting are studied and ranked by comparing with the optimal monetary policy under commitment. We find that the ranking of the simple rules can be mapped to the terms-of-trade variability that the rule allows relative to what a particular shock optimally calls for. It turns out that inflation targeting dominates the other two rules under productivity or velocity shocks, whereas monetary targeting is the best performer under fiscal shocks.

Keywords: Sticky prices; fixed exchange rates; monetary targeting; inflation targeting; optimal monetary policy. (search for similar items in EconPapers)
JEL-codes: E4 E5 F4 (search for similar items in EconPapers)
Date: 2007-03-25

Forthcoming in Canadian Journal of Economics.

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Persistent link: http://EconPapers.repec.org/RePEc:isu:genres:12767

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