Working Paper: NBER ID: w8604
Authors: Richard H. Clarida; Jordi Gali; Mark Gertler
Abstract: This paper develops a new open economy macro model of optimal monetary for a small open economy. Our main result is that in this model, the optimal policy problem for the small open economy is isomorphic to the closed economy case studied in Clarida, Gali, Gertler (1999). In particular, the optimal policy can be implemented with a Taylor Rule under which the domestic interest rate adjusts to the equilibrium real interest rate and expected inflation in domestic prices.
Keywords: optimal monetary policy; open economy; closed economy; Taylor rule
JEL Codes: F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal monetary policy for a small open economy is isomorphic to that of a closed economy (F41) | domestic interest rate adjusts to the equilibrium real interest rate and expected inflation (E43) |
| degree of openness (F43) | central bank response to inflationary pressures (E52) |
| perfect exchange rate pass-through (F31) | central bank should prioritize targeting domestic inflation (E52) |
| central bank's policy decisions (targeting domestic inflation) (E52) | effects of exchange rate fluctuations on overall economic stability (F31) |