International policy coordination and simple monetary policy rules, Issues 2006-2164
International Monetary Fund, 2006 - Business & Economics - 26 pages
This paper studies the optimal design of monetary policy in an optimizing two-country sticky price model. We suppose that the production sequence of final consumption goods stretches across both countries and is associated with vertical trade. Prices of final consumption goods are sticky in the consumer's currency. Pursuing an inward-looking policy, as suggested in recent work, is not optimal in this set-up. We also ask which simple, i.e. non-optimal, targeting rule best supports the welfare maximizing policy. The results hinge critically on the degree of price flexibility and the relative importance of cost-push and productivity shocks. In many cases, a strict targeting of price indices like producer or consumer price indices is dominated by rules that allow for some fluctuations in prices such as nominal income or monetary targeting.
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assumed central bank consumer price index Consumer Price Targeting consumption goods prices consumption goods sector coordinated cost-push shocks CPI targeting degree of price denotes Devereux and Engel expected log deviation final consumption final goods producers fixed exchange rate Fixed-price agents fixed-price and flex-price flex-price agents flex-price consumption flex-price producers foreign intermediate given in equation global welfare home and foreign home bias intermediate goods output intermediate goods sector McCallum and Nelson monetary policy rules monetary rule monetary targeting money supply rules nominal income targeting non-stochastic terms open economies optimal monetary policy optimal policy rule optimal price given Optimal Price Setting optimal rule pass-through pFyF policymakers price flexibility price index targeting price stickiness producer price index producer price targeting productivity and cost-push productivity shocks Purchasing power parity simple rules simple targeting rules Sutherland 2004a Svensson targeting and monetary targeting implies targeting the producer variable welfare criterion welfare loss welfare results