Optimal inflation in an open economy with imperfect competition

David Arseneau

No 2004-25, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

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 is not a general result. Monetary authorities face 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 coordination failure. International monetary cooperation helps to mitigate this coordination failure and, as a result, can lead to more efficient equilibria. Monetary union ensures the maximum gain from cooperation by restoring the optimality of the global Friedman rule, placing the world economy at the Pareto frontier.

Keywords: Monetary policy; Inflation (Finance) (search for similar items in EconPapers)
Date: 2004
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (5)

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