Working Paper: CEPR ID: DP425
Authors: Marcus H. Miller; Mark H. Salmon
Abstract: In a continuous time model of two symmetric open economies, with a floating exchange rate, we find that the pay-off to the policy coordination depends systematically on the heterogeneity of their inflation experience. While monetary policy coordination improves welfare when there is a common rate of underlying inflation, it exacerbates the `time-consistency' problem arising when there are differences. Since the principle of `certainty equivalence' applies to time-consistent policy in linear quadratic models, we are also able to give a stochastic interpretation of the deterministic results.
Keywords: policy coordination; time consistency; certainty equivalence; floating exchange rates
JEL Codes: 133; 134; 325
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroeconomic policy coordination (F42) | welfare outcomes (I38) |
| inflation experiences are similar (E31) | macroeconomic policy coordination improves welfare (F42) |
| inflationary conditions differ (E31) | coordination leads to inefficiencies (D61) |
| time consistency problems (E61) | coordination leads to inefficiencies (D61) |
| correlation of inflationary supply-side shocks is high (E31) | coordination pays in expected terms (J33) |
| correlation of inflationary supply-side shocks is low or negative (E31) | coordination may not pay in expected terms (C72) |
| policy coordination (F42) | welfare outcomes (I38) |