EconPapers    
Economics at your fingertips  
 

Time-consistent monetary policy, terms of trade manipulation and welfare in open economies

Sebastian Schmidt ()

No 2128, Working Paper Series from European Central Bank

Abstract: A key insight from the open economy literature is that domestic price stability is in general not optimal for countries that exert some market power over their terms of trade. Under commitment, a national benevolent monetary policymaker improves upon the allocation associated with stable domestic prices by manipulating the terms of trade to her own country’s advantage. In this paper, I study optimal monetary policy in a sticky-price small open economy model when the policymaker lacks a commitment device. Without commitment, the benevolent policymaker’s attempt to improve national welfare by manipulating the terms of trade can be self-defeating. By steering international relative prices the discretionary policymaker induces fluctuations in domestic prices, the costs of which she is unable to fully internalize in her decision-making. Society may thus be better off if it appoints an inward-looking policymaker who aims for domestic price stability and resists the temptation to exploit the country’s monopoly power in trade. Accounting for the effective lower bound on nominal interest rates further strengthens the case for the inward-looking policy objective. JEL Classification: E52, F41

Keywords: delegation; discretion; optimal monetary policy; small open economy; terms of trade externality (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mon and nep-opm
Date: 2018-02
Note: 3072374
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2128.en.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20182128

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank 60640 Frankfurt am Main, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Official Publications ().

 
Page updated 2019-09-19
Handle: RePEc:ecb:ecbwps:20182128