Price stability in open economies

Abstract

This paper studies the theoretical 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. Importantly, we show that cooperative and non-cooperative solutions do not coincide despite market completeness and producer currency pricing. We study the conditions under which quadratic approximations of single countries' welfare can be correctly evaluated by relying only on log-linear approximations of the equilibrium condition