Monetary Policy and Exchange Rate Volatility in a Small Open Economy

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ID: 294843
2005
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Abstract
We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to a simple representation in domestic inflation and the output gap. We use the resulting framework to analyse the macroeconomic implications of three alternative rule-based policy regimes for the small open economy: domestic inflation and CPI-based Taylor rules, and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with the suboptimal rules.
Reference Key
openalex_W3021164001 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Jordi Galı́, Tommaso Monacelli
Journal The Review of Economic Studies
Year 2005
DOI
10.1111/j.1467-937x.2005.00349.x
URL
https://doi.org/10.1111/j.1467-937x.2005.00349.x
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