Working Paper: CEPR ID: DP3355
Authors: Richard Clarida; Jordi Gal; Mark Gertler
Abstract: We study the international monetary policy design problem within an optimizing two-country sticky price model, where each country faces a short run trade-off between output and inflation. The model is sufficiently tractable to solve analytically. We find that in the Nash equilibrium, the policy problem for each central bank is isomorphic to the one it would face if it were a closed economy. Gains from co-operation arise, however, that stem from the impact of foreign economic activity on the domestic marginal cost of production. While under Nash central banks need only adjust the interest rate in response to domestic inflation, under co-operation they should respond to foreign inflation as well. In either scenario, flexible exchange rates are desirable.
Keywords: cooperation; international monetary policy; marginal cost; nash equilibrium
JEL Codes: E50; F30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic Inflation (E31) | Interest Rate Decisions of Central Banks (E43) |
| Foreign Economic Activity (F49) | Domestic Policy Decisions (H59) |
| Foreign Inflation (F31) | Domestic Policy Decisions (H59) |
| Gains from Cooperation (C71) | Improved Welfare (I39) |