Paper #835

Título:

Monetary policy and exchange rate volatility in a small open economy

Autores:

Jordi Galí y Tommaso Monacelli

Data:

Julio 2004

Resumen:

We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to simple representation in domestic inflation and the output gap. We use the resulting framework to analyze 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.

Palabras clave:

Small open economy, optimal monetary policy, sticky prices, exchange rate peg, exchange rate volatility

Códigos JEL:

E52, F41

Área de investigación:

Macroeconomía y Economía Internacional

Publicado en:

Review of Economic Studies, 72, 707-734, 2005

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