Working Paper: NBER ID: w8870
Authors: Richard Clarida; Jordi Gali; 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 tradeoff 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 cooperation 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 cooperation they should respond to foreign inflation as well. In either scenario, flexible exchange rates are desirable.
Keywords: international monetary policy; sticky prices; Nash equilibrium; cooperation
JEL Codes: E5; F3
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 Adjustments (E43) |
| Foreign Economic Conditions (F49) | Domestic Policy Outcomes (H53) |
| Cooperation Among Central Banks (E58) | Welfare Gains (D69) |