Monetary Policy and Exchange Rate Volatility in a Small Open Economy

Galí, Jordi and Tommaso Monacelli
Authors registered in the RePEc Author Service: Jordi Galí

No 3346, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to a tractable canonical system in domestic inflation and the output gap. We employ this framework to analyse the macroeconomic implications of three alternative monetary policy regimes for the small open economy: domestic inflation targeting, CPI targeting and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with suboptimal regimes.

Keywords: Small open economy; Optimal monetary policy; Sticky prices; Exchange rate peg; Exchange rate volatility (search for similar items in EconPapers)
JEL-codes: E52 F41 (search for similar items in EconPapers)
Date: 2002-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (173)

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Related works:
Working Paper: Monetary Policy and Exchange Rate Volatility in a Small Open Economy (2015)
Journal Article: Monetary Policy and Exchange Rate Volatility in a Small Open Economy (2005)
Working Paper: Monetary Policy and Exchange Rate Volatility in a Small Open Economy (2002)
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