Price Stability in Open Economies

Abstract

This paper studies the conditions under which price stability is the optimal policy in a two-country open-economy model with imperfect competition and price stickiness. Special conditions on the levels of country-specific distortionary taxation and the intratemporal and intertemporal elasticities of substitution need to be satisfied. These restrictions apply to both cooperative and non-cooperative settings. Most importantly, we show that cooperative and non-cooperative solutions do not coincide despite market completeness and producer currency pricing. In this framework, our analysis suggests a role for international policy coordination. IntroductionThere is a large consensus among policymakers and students of monetary policy that price stability should be the main objective of a Central Bank. This is a desirable goal insofar as it can induce an efficient allocation of resources across different uses and times. An increasing literature on monetary policy evaluation has started to address the issue of optimal monetary policy in stochastic general-equilibrium models with monopolistic competition and price stickiness. * This is a revised version of our working paper Benigno and Benigno (2001a). We are indebted to Michael Woodford for helpful and detailed comments. We thank also Peter Andrews, Jinill Kim, Paolo Pesenti and Simon Price. We thank three anonymous referees for helpful comments. All errors are our own.

Gains from Coordination in a Multi-Sector Open Economy: Does it Pay to be Different?

“…In this final step, we are essentially solving a linear-quadratic (LQ) problem with rational expectations. The LQ approach has become a popular tool in studying optimal monetary policy in closed economy models with a single sector (e.g., Rotemberg and Woodford (1997)) or multiple sectors (e.g., Erceg, et al (2000), Huang and Liu (2004b)), and in open economy models with a single traded sector (e.g., Clarida, et al (2002), Benigno and Benigno (2003), Gali andMonacelli (2002), andPappa (2004) sectors and multiple sources of nominal rigidity, for both a regime with independent central banks (i.e., the Nash regime) and one with cooperating central banks (i.e., the cooperating regime). 8…”

“…8 Our approach differs slightly from that adopted in the open-economy papers mentioned here [e.g., Clarida, et al (2002), Benigno and Benigno (2003), Gali and Monacelli (2002), and Pappa (2004)] in that we do not limit ourselves from the outset to taking first-order approximations to the private sectors' optimizing conditions. An alternative solution method is to take second-order approximations throughout the model and then to compute approximate optimal policy rules through non-linear simulations of the second-order system [e.g., Tille (2004), Sutherland (2002b), Tille (2002), Tscharov (2004].…”

“…For instance, the gains from coordination can be related to the degree of exchange-rate pass-through [e.g., , Duarte (2003), and Corsetti and Pesenti (2005)]. 1 Even with perfect exchange-rate pass-through, inward-looking monetary policy can be suboptimal and be improved upon by coordination, depending on the values of the intertemporal elasticity and the elasticity of substitution between goods produced in different countries [e.g., Clarida, et al (2002), Benigno and Benigno (2003), Pappa (2004), Sutherland (2002a, and Tsacharov (2004)]. Policy coordination may also produce welfare gains if the international financial markets are incomplete [e.g., Benigno (2001) and Sutherland (2002b)], policy makers have imperfect information [e.g., Dellas (2004)], or domestic shocks are imperfectly correlated across sectors [e.g., Canzoneri, et al (2004)].…”

“…In addition, as is well known in the closed-economy literature, staggered price-setting leads to inefficient price dispersion, giving rise to an additional source of inefficiency that optimal monetary policy needs to deal with. 3 See, for example, Clarida et al (2002), Benigno andBenigno (2003), andPappa (2004), among others.…”

To be or not to be in monetary union: A synthesis

“…One that studies the optimal degree of exchange rate flexibility (Benigno andBenigno, 2003, Devereux andEngel, 2007). And another that deals with the benefits from international policy coordination.…”