Working Paper: CEPR ID: DP3226
Authors: Gianluca Benigno; Pierpaolo Benigno
Abstract: This Paper presents a two-country dynamic general equilibrium model with imperfect competition and nominal price rigidities in which terms of trade shocks coexist with inefficient supply shocks. We analyse the features of the optimal cooperative solution. While terms of trade shocks should be offset by movements in the exchange rate, inefficient supply shocks are more likely to make a case for a fixed exchange rate regime. Surprisingly, we show that the optimal cooperative solution can be implemented in a strategic context through inflation-targeting regimes. Under these regimes each monetary authority weighs only domestic targets, namely GDP inflation and output gap. Even if there are gains from cooperation, inward-looking monetary policymakers can achieve the first best.
Keywords: international monetary cooperation; monetary delegation
JEL Codes: F33; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| efficient terms of trade shocks (F14) | exchange rate changes (F31) |
| inefficient supply shocks (E31) | fixed exchange rate regime (F33) |
| design of monetary policy institutions (E52) | economic outcomes (F61) |
| weights assigned to domestic targets (H56) | first-best outcome (H21) |