Optimal Inflation in an Open Economy

David Arseneau

No 279, Econometric Society 2004 North American Summer Meetings from Econometric Society

Abstract: This paper uses a two-country, monetary general equilibrium model with imperfect competition to study the optimal rate of inflation in an open economy. In contrast with the closed economy literature, when policy is set non-cooperatively in the open economy, the optimality of the Friedman rule -- setting the money growth rate such that the nominal interest rate goes to zero -- is not a general result. An optimizing monetary authority faces an incentive to use the inflation tax to gain a "beggar-thy-neighbor" advantage over the terms of trade. Strategic use of the inflation tax, however, results in a coordination failure that reduces overall welfare. International monetary cooperation helps to mitigate this coordination failure and, as a result, can lead to more efficient equilibria. An institutional arrangement such as a monetary union ensures the maximum gain from cooperation by restoring the optimality of the Friedman rule, placing the world economy at the pareto frontier

Keywords: Optimal Monetary Policy; Friedman Rule; Policy Coordination (search for similar items in EconPapers)
JEL-codes: E52 F41 F42 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ecm:nasm04:279

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