Optimal Monetary Policy in an Open Economy

Peter J. Stemp and Stephen J Turnovsky

No 2018, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper analyzes the optimal intertemporal tradeoff between inflation and output in an open economy under perfect foresight. The announcement of the optimal plan may, or may not, generate an initial jump in the exchange rate. That depends upon the real adjustment costs, which such unanticipated changes impose on the economy. In the case that such jumps occur, the question of time consistency of the optimal policy arises. A time consistent solution is obtained provided: (i) the policy maker is not too myopic; (ii) the adjustment costs associated with the jump in the exchange rate are of an appropriate form. The optimal monetary rule is derived and properties of this rule, as well as the overall optimal adjustment of the economy are discussed.

Date: 1986-09
Note: ITI IFM
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Published as Stemp, Peter J. Stemp and Stephen J. Turnovsky. "Optimal Monetary Policy inan Open Economy," European Economic Review, Vol. 31, No. 5, July 1987, pp. 1113-1135.

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