Currency Misalignments and Optimal Monetary Policy: A Reexamination / Charles Engel.

Format:

Book

Author/Creator:

Engel, Charles.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w14829.

NBER working paper series no. w14829

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Currency Misalignments and Optimal Monetary Policy

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2009.

Summary:

This paper examines optimal monetary policy in an open-economy two-country model with sticky prices. We show that currency misalignments are inefficient and lower world welfare. We find that optimal policy must target not only inflation and the output gap, but also the currency misalignment. However the interest rate reaction function that supports this targeting rule may involve only the CPI inflation rate. This result illustrates how examination of "instrument rules" may hide important trade-offs facing policymakers that are incorporated in "targeting rules". The model is a modified version of Clarida, Gali, and Gertler's (JME, 2002). The key change is that we allow pricing to market or local-currency pricing and consider the policy implications of currency misalignments. Besides highlighting the importance of the currency misalignment, our model also gives a rationale for targeting CPI, rather than PPI, inflation.

Notes:

Print version record

April 2009.