Optimal monetary policy in open economies revisited

Ippei Fujiwara, Jiao Wang

Research output: Contribution to journalArticle

4 Citations (Scopus)

Abstract

This paper revisits optimal monetary policy in open economies, in particular, focusing on the noncooperative policy game under local currency pricing in a two-country dynamic stochastic general equilibrium model. We first derive the quadratic loss functions which noncooperative policy makers aim to minimize. Then, we show that noncooperative policy makers face extra trade-offs regarding stabilizing real marginal costs induced by deviations from the law of one price under local currency pricing, and that optimal monetary policy seeks to stabilize CPI inflation rates and more so under noncooperation than it does under cooperation. As a result of the increased number of stabilizing objectives, welfare gains from cooperation emerge even when two countries face only technology shocks. Still, gains from cooperation are not large, implying that frictions other than nominal rigidities are necessary to strongly recommend cooperation as an important policy framework to increase global welfare.

Original languageEnglish
Pages (from-to)300-314
Number of pages15
JournalJournal of International Economics
Volume108
DOIs
Publication statusPublished - 2017 Sep 1

Keywords

  • Local currency pricing
  • Noncooperative game
  • Optimal monetary policy

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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