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International Risk-Sharing and Optimal Monetary Policy in a Small Commodity-Exporting Economy

Valery Charnavoki

Russian Journal of Money and Finance, 2019, vol. 78, issue 2, 3-27

Abstract: This paper evaluates the welfare implications of alternative monetary policy regimes for a small commodity-exporting economy. In line with the existing literature, welfare analysis shows that a flexible exchange rate regime tends to outperform a fixed nominal exchange rate. However, this paper shows that the welfare costs of a nominal peg vary considerably with the extent of international risk-sharing. In a model with complete and frictionless asset markets, real exchange rate volatility is small, and welfare losses from the nominal peg are negligible. By contrast, under financial autarky, a fixed nominal exchange rate generates significant volatility in inflation and results in large welfare costs. I also consider the welfare properties of flexible regimes, showing that core consumer inflation targeting and non-commodity domestic inflation targeting are not generally optimal, although their welfare costs are small compared to those of a fixed regime. Furthermore, the welfare ranking of these two regimes might depend on the currency in which the tradable goods are priced (producer-currency pricing vs. local-currency pricing).

Keywords: commodity currency; international risksharing; optimal monetary policy; exchange rate regime (search for similar items in EconPapers)
JEL-codes: E52 F41 Q43 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.31477/rjmf.201902.03

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Handle: RePEc:bkr:journl:v:78:y:2019:i:2:p:3-27