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Optimal Monetary Policy in a Currency Area

By Pierpaolo Benigno

Abstract

This paper investigates how monetary policy should be conducted in a two-region, general equilibrium model with monopolistic competition and price stickiness. This framework delivers a simple welfare criterion based on the utility of the consumers that has the usual tradeoff between stabilizing inflation and output. If the two regions share the same degree of nominal rigidity, the terms of trade are completely insulated from monetary policy and the optimal outcome is obtained by targeting a weighted average of the regional inflation rates. These weights coincide with the economic sizes of the region. If the degrees of rigidity are different, the optimal plan implies a high degree of inertia in the inflation rate. But an inflation targeting policy in which higher weight is given to the inflation in the region with higher degree of nominal rigidity is nearly optimal

Topics: optimal monetary policy, currency area, sticky prices, welfare criterion
Year: 2001
OAI identifier: oai:CiteSeerX.psu:10.1.1.197.884
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