Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices

Juan Medina and Ruy Lama

No 2007/217, IMF Working Papers from International Monetary Fund

Abstract: This paper studies optimal monetary policy in a two-sector small open economy model under segmented asset markets and sticky prices. We solve the Ramsey problem under full commitment, and characterize the optimal monetary policy in a calibrated version of the model. The findings of the paper are threefold. First, the Ramsey solution mimics the allocations under flexible prices. Second, under the optimal policy the volatility of non-tradable inflation is close to zero. Third, stabilizing nontradable inflation is optimal regardless of the financial structure of the small open economy. Even for a moderate degree of price stickiness, implementing a monetary policy that mitigates asset market segmentation is highly distortionary. This last result suggests that policymakers should resort to other policy instruments in order to correct financial imperfections.

Keywords: WP; monetary policy; market segmentation; sticky price; Optimal monetary policy; asset market segmentation; sticky prices; nominal interest rate; sensitivity analysis; open economy; substitution effect; inflation rate; Securities markets; Inflation; Consumption; Asset prices (search for similar items in EconPapers)
Pages: 55
Date: 2007-09-01
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Citations: View citations in EconPapers (4)

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Related works:
Working Paper: Optimal Monetary Policy in a Small Open Economy under Segmented Asset Markets and Sticky Prices (2005)
Working Paper: Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices (2004)
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