Strategic Monetary Policy in Open Economies

Louphou Coulibaly and Charles Engel

No 35928, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We examine optimal non-cooperative monetary policy in a two-country New Keynesian setting with complete financial markets and pricing to market for goods. In contrast to the case in which the law of one price holds for goods, currency misalignments are an important consideration even for self-oriented policymakers. Financial markets are critical in the analysis. Under “full” commitment, the optimal policy considers the effects on asset values and hence wealth distribution across countries. Optimal policy under full commitment differs from the “partial” commitment case in which the policy commitment is not made until after asset markets clear. Surprisingly, the optimal targeting rule under strategic policy with full commitment is the same as under cooperative policy. In this setting, changes in state-contingent claim prices offset the wealth a self-oriented policymaker might seek through terms-of-trade manipulation, and we show that there are no gains from cooperation. Although a policy chosen under partial commitment may be desirable from a country’s perspective, the resulting Nash equilibrium yields lower welfare.

JEL-codes: E44 E52 F31 F41 F42 (search for similar items in EconPapers)
Date: 2026-10
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-mon
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