Openness and optimal monetary policy

Giovanni Lombardo and Federico Ravenna

No 1279, Working Paper Series from European Central Bank

Abstract: We show that the composition of imports has important implications for the optimal volatility of the exchange rate. Using input-output data for 25 countries we document substantial differences in the import and non-tradable content of final demand components, and in the role played by imported inputs in domestic production. We build a business cycle model of a small open economy to discuss how the problem of the optimizing policy-maker changes endogenously as the composition of imports and of final demand is altered. Contrary to models where steady state trade openness is entirely characterized by home bias, we find that trade openness is a very poor proxy of the welfare impact of alternative monetary policies. Finally, we quantify the loss from an exchange rate peg relative to the Ramsey policy conditional on the composition of imports, using parameter values that are estimated from OECD input-output tables data. We find that the main determinant of the losses is the share of non-traded goods in final demand. JEL Classification: E52, E31, F02, F41

Keywords: exchange rate regimes; international trade; Non-tradable Goods; Optimal Policy (search for similar items in EconPapers)
Date: 2010-12
New Economics Papers: this item is included in nep-cba, nep-dge, nep-int, nep-mon and nep-opm
Note: 656519
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Openness and optimal monetary policy (2014)
Working Paper: Openness and Optimal Monetary Policy (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20101279

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