Working Paper: CEPR ID: DP4012
Authors: Robert Kollmann
Abstract: This Paper analyses the welfare effects of monetary policy rules in a quantitative business cycle model of a two-country world. The model features staggered price setting, and shocks to productivity and to the uncovered interest rate parity (UIP) condition. UIP shocks have a sizable negative effect on welfare, when trade links are strong. An exchange rate peg may raise world welfare, if the peg eliminates the UIP shocks. The model explains the empirical finding that more open economies are more likely to adopt a peg.
Keywords: business cycles; exchange rate regime; interest rate parity
JEL Codes: E40; F30; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| UIP shocks (J65) | welfare (I38) |
| exchange rate peg (F31) | welfare (I38) |
| UIP shocks (J65) | consumption volatility (E20) |
| UIP shocks (J65) | real exchange rate volatility (F31) |
| trade openness (F43) | effectiveness of peg (F35) |
| exchange rate peg (F31) | mitigate UIP shocks (J65) |