 Optimal Monetary Policy in a Small Open Economy with Home BiasEster Faia and Tommaso Monacelli Journal of Money, Credit and Banking, 2008, vol. 40, issue 4, 721-750 Abstract: We analyze optimal monetary policy in a small open economy characterized by home bias in consumption. Peculiar to our framework is the application of a Ramsey-type analysis to a model of the recent open-economy New Keynesian literature. We show that home bias in consumption is a sufficient condition for inducing the monetary policymaker of an open economy to deviate from a strategy of strict markup stabilization and contemplate some (optimal) degree of exchange rate stabilization. We focus on the optimal setting of policy both in the case of firms setting prices one period in advance and in a gradual fashion subject to adjustment costs. While the first setup allows us to analytically highlight home bias as an independent source of equilibrium markup variability, the second setup allows to study the effects of future expectations on the optimal policy problem and the effect of home bias on optimal inflation volatility. The latter, in particular, is shown to be related to the degree of trade openness in a U-shaped fashion, whereas exchange rate volatility is monotonically decreasing in openness. Copyright (c) 2008 The Ohio State University. Date: 2008 There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it. Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:mcb:jmoncb:v:40:y:2008:i:4:p:721-750 Access Statistics for this article Journal of Money, Credit and Banking is currently edited by Robert deYoung, Paul Evans, Pok-Sang Lam and Kenneth D. West More articles in Journal of Money, Credit and Banking from Blackwell Publishing |
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