The timing of asset trade and optimal policy in dynamic open economies

Using a standard open economy DSGE model, it is shown that the timing of asset trade relative to policy decisions has a potentially important impact on the welfare evaluation of monetary policy at the individual country level. If asset trade in the initial period takes place before the announcement of policy, a national policymaker can choose a policy rule which reduces the work effort of households in the policymaker’s country in the knowledge that consumption is fully insured by optimally chosen international portfolio positions. But if asset trade takes place after the policy announcement, this insurance is absent and households in the policymaker’s country bear the full consumption consequences of the chosen policy rule. The welfare incentives faced by national policymakers are very different between the two cases. Numerical examples confirm that asset market timing has a significant impact on the optimal policy rule.PostprintPeer reviewe

Endogenous Price Flexibility and Optimal Monetary Policy

Much of the literature on optimal monetary policy uses models in which the degree of nominal price flexibility is exogenous. There are, however, good reasons to suppose that the degree of price flexibility adjusts endogenously to changes in monetary conditions. This paper extends the standard New Keynesian model to incorporate an endogenous degree of price flexibility. The model shows that endo?genising the degree of price flexibility tends to shift optimal monetary policy towards complete inflation stabilisation, even when shocks take the form of cost-push distur?bances. This contrasts with the standard result obtained in models with exogenous price flexibility, which show that optimal monetary policy should allow some degree of inflation volatility in order to stabilise the welfare-relevant output gap.Welfare, Endogenous Price Flexibility, Optimal Monetary Policy.

The Timing of Asset Trade and Optimal Policy in Dynamic Open Economies

Using a standard open economy DSGE model, it is shown that the timing of asset trade relative to policy decisions has a potentially important impact on the welfare evaluation of monetary policy at the individual country level. If asset trade in the initial period takes place before the announcement of policy, a national pol?icymaker can choose a policy rule which reduces the work effort of households in the policymaker¡¯s country in the knowledge that consumption is fully insured by optimally chosen international portfolio positions. But if asset trade takes place after the policy announcement, this insurance is absent and households in the poli?cymaker¡¯s country bear the full consumption consequences of the chosen policy rule. The welfare incentives faced by national policymakers are very different between the two cases. Numerical examples confirm that asset market timing has a significant impact on the optimal policy rule.Optimal policy; monetary policy in open economies; international financial markets.

Local Currency Pricing, Foreign Monetary Shocks and Exchange Rate Policy

The implications of local currency pricing (LCP) for monetary regime choice are analysed for a country facing foreign monetary shocks. In this analysis expenditure switching is potentially welfare reducing. This contrasts with the existing LCP literature, which focuses on productivity shocks and thus analyses a world where expenditure switching is welfare enhancing. This paper shows that, when home and foreign pro?ducers follow LCP, expenditure switching is absent and a floating rate is preferred by the home country. But when only home producers follow LCP, expenditure switching is present and a fixed rate can be welfare enhancing for the home country.Monetary Policy, Foreign Monetary Shocks, Expenditure Switching, Exchange Rates, Local Currency Pricing, Reference Currency.

Can Endogenous Changes in Price Flexibility Alter the Relative Welfare Performance of Exchange Rate Regimes?

A dynamic general equilibrium model of a small open economy is presented where agents may choose the frequency of price changes. A fixed exchange rate is compared to inflation targeting and money targeting. A fixed rate generates more price flexibility than the other regimes when the expenditure switching effect is relatively weak, while money targeting generates more flexibility when the expenditure switching effect is strong. These endogenous changes in price flexibility can lead to changes in the welfare performance of regimes. But, for the model calibration considered here, the extra price flexibility generated by a peg does not compensate for the loss of monetary independence. Inflation targeting yields the highest welfare level despite generating the least price flexibility of the three regimes considered.

Interest Rate Rules and Welfare in Open Economies

This paper analyses the welfare performance of a set of five alternative interest rate rules in an open economy stochastic dynamic general equilibrium model with nominal rigidities. A rule with a lagged interest rate term, high feedback on inflation and low feedback on output is found to yield the highest welfare for a small open economy. This result is robust across different degrees of openness, different sources of home and foreign shocks, alternative foreign monetary rules and different specifications for price setting behaviour. The same rule emerges as both the Nash and cooperative equilibria in a two-country version of the model.Welfare, Monetary Policy, Interest Rate Rules, Second Order Approximation.

Local currency pricing, foreign monetary shocks and exchange rate policy

This research was supported by ESRC [grant number ES/I024174/1]The implications of local currency pricing (LCP) for monetary regime choice are analysed for a country facing foreign monetary shocks. In this analysis expenditure switching is potentially welfare reducing. This contrasts with the existing LCP literature, which focuses on productivity shocks and thus analyses a world where expenditure switching is welfare enhancing. This paper shows that, when home and foreign producers follow LCP, expenditure switching is absent and a floating rate is preferred by the home country. But when only home producers follow LCP, expenditure switching is present and a fixed rate can be welfare enhancing for the home country.PostprintPeer reviewe