The recent empirical evidence shows that most international prices are sticky in dollars. This paper studies the optimal non-cooperative monetary policy and the welfare implications of dollar pricing in a context of an open economy model with nominal rigidities. We establish the following results: 1) as in a closed economy, the optimal policy in both the U.S. and other economies stabilizes prices of local producers; 2) this policy generates asymmetric spillovers between countries such that the U.S. has a free oating exchange rate and an independent monetary policy, while other countries partially peg their exchange rates to the dollar giving rise to a "global monetary cycle"; 3) capital controls cannot insulate countries from U.S. spillovers; 4) the optimal cooperative policy is hard to implement because of the con ict of interest between countries; 5) there are potential gains from dollar pricing for the U.S., while other countries can bene t from forming a currency union such as the Eurozone.
We investigate open economy dimensions of optimal monetary and fiscal policy at the zero lower bound (ZLB) in a small open economy model. At positive interest rates, the trade elasticity has negligible effects on optimal policy. In contrast, at the ZLB, the trade elasticity plays a key role in optimal policy prescriptions. The way in which the trade elasticity shapes policy depends on the government's ability to commit. Under discretion, the increase in government spending at the ZLB depends critically on the trade elasticity. Under commitment, the difference between future and current policies, both for domestic inflation and government spending, is smaller when the trade elasticity is higher.JEL codes: E31, E52, E58, E61, E62, E63, F41
Recent empirical evidence shows that most international prices are sticky in dollars. This paper studies the optimal policy implications of this fact in the context of an open economy model, allowing for an arbitrary structure of asset markets, general preferences and technologies, time-or state-dependent price setting, a rich set of shocks, and endogenous currency choice. We show that although monetary policy is less efficient and cannot implement the flexible-price allocation, inflation targeting remains robustly optimal in non-U.S. economies. The implementation of this non-cooperative policy results in a "global monetary cycle" with other countries partially pegging their exchange rates to the dollar and importing the monetary stance of the U.S. In spite of the aggregate demand externality, capital controls cannot unilaterally improve the allocation and are useful only when coordinated across countries. The optimal U.S. policy, on the other hand, deviates from inflation targeting to take advantage of its effects on global product and asset markets, generating negative spillovers on the rest of the world. International cooperation benefits other countries by improving global demand for dollar-invoiced goods, but may be hard to sustain because it is not in the self-interest of the U.S. At the same time, countries can still gain from local forms of policy coordination -such as forming a currency union like the Eurozone.
Empirical evidence shows that most international prices are sticky in dollars. This paper studies the policy implications of this fact in the context of an open economy model with general preferences, technologies, asset markets, nominal rigidities, and a rich set of shocks. We show that although monetary policy is less efficient and cannot implement the flexible-price allocation, inflation targeting and a floating exchange rate remain robustly optimal in non-US economies. The capital controls cannot unilaterally improve the allocation and are useful only when coordinated across countries. International cooperation benefits other economies, but is not in the self-interest of the United States. (JEL E31, E52, F14, F31, F38, F41)
We present a tractable, quantitative model of sovereign borrowing that delivers empirically relevant regularities, such as graduation from default, sovereign debt spreads that may be high for an extended period of time, high debt-to-GDP ratios, and high default rates. The model is an asymmetric-information extension of otherwise standard models of endogenous default on sovereign debt, with borrowing levels determined in equilibrium. Governments could be of di↵erent types based on their level of responsibility (cost of default as perceived by the politicians). Only the governments observe their level of responsibility. International investors try to infer the unobserved types based on the history of all observable actions, which gives irresponsible politicians an incentive to choose the same actions as responsible ones would. Governments could tolerate periods of high interest rates without defaulting to signal that they are of better type and to gain good reputation. This leads to lower interest rates during future recessions. For the same reason, even responsible governments should pay at first high interest rates in order to signal their type and thus "graduate from default" afterwards. A calibrated version of the model features these regularities, matches standard business cycle moments, and leads to a more realistic default rate in equilibrium, with parameter values same as in the existing literature.
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