Optimal Monetary Policy in an Interdependent World

Arbeitspapier

In the literature on international monetary policy, the paradigm is that gains from coordination are fairly small. Monetary policy is conducted to stabilize macroeconomic fluctuations and gains from policy coordination arise from preventing national monetary authorities from strategically manipulating the terms of trade by means of these stabilization policy instruments. However, as it has been emphasized by \cite{lucas:2003a}, welfare gains from stabilizing fluctuations are generically small since they are of second order. In this paper, I develop a dynamic stochastic two-country model with sticky wages and a cash-in-advance restriction which is in the spirit of the New Open Economy Macroeconomics framework. In this environment, monetary authorities can manipulate the terms of trade by conducting a general short-run monetary policy using both the nominal interest rate and the money supply. The money supply affects the terms of trade by altering the nominal exchange rate ex post and it is used in the traditional way so as to stabilize macroeconomic fluctuations. The nominal interest rate affects the terms of trade by changing expected inflation ex ante. Self-oriented national policymakers use the nominal interest rates to raise the terms of trade ex ante. This leads to an inefficient inflation tax whose welfare effects are of first order. Consequently, gains from monetary policy coordination are of first order.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bonn Econ Discussion Papers ; No. 10/2007

Classification and Topics

• Classification: Wirtschaft ; Open Economy Macroeconomics ; International Policy Coordination and Transmission
• Subject: International Policy Coordination ; General Short-Run Monetary Policy ; New Open Economy Macroeconomics ; Geldpolitik ; Terms of Trade ; Internationale wirtschaftspolitische Koordination ; Wohlfahrtseffekt ; Neue Makroökonomik offener Volkswirtschaften ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Evers, Michael P.
• Event: Veröffentlichung
• (who): University of Bonn, Bonn Graduate School of Economics (BGSE)
• (where): Bonn
• (when): 2007

Further information

• Handle: http://hdl.handle.net/10419/27151
• Last update: 10.03.2025, 11:45 AM CET