Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility

Michael Devereux and Charles Engel

No 7665, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a welfare-based model of monetary policy in an open economy. We focus on the extent to which monetary policy should be employed in maintaining the exchange rate. The traditional approach maintains that exchange rate flexibility is desirable in the presence of real country-specific shocks that require adjustment in relative prices. However, in the light of empirical evidence on nominal price response to exchange-rate changes specifically, that there appears to be a large degree of local-currency pricing in industrialized countries the expenditure-switching role played by nominal exchange rates may be exaggerated in the traditional literature. In the presence of local-currency, we find that optimal monetary policy in response to real shocks pricing is fully consistent with fixed exchange rates. On the other hand, when real country-specific shocks are not important, and when a country's monetary sector is stable, the case for freely floating rates (a monetary policy in which exchange rates are not a consideration) is strengthened in the presence of local-currency pricing.

JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 2000-04
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-mon
Note: IFM
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Citations: View citations in EconPapers (171)

Published as Devereux, Michael B. and Charles Engel. "Monetary Policy In The Open Economy Revisited: Price Setting And Exchange-Rate Flexibility," Review of Economic Studies, 2003, v70(4,Oct), 765-783.

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Journal Article: Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility (2003)
Working Paper: Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibiity (2000)
Working Paper: Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility (2000)
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