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Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices

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Ruy Lama
Juan Pablo Medina

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Abstract

This paper studies optimal monetary policy in a two-sector small open economy model under segmented asset markets and sticky prices. We solve the Ramsey problem under full commitment, and characterize the optimal monetary policy in a version of the model calibrated to the Chilean economy. The contributions of the paper are twofold. First, under the optimal policy the volatility of nontradable inflation is near zero. Second, stabilizing non-tradable inflation is optimal regardless of the financial structure of the small open economy. Even for a moderate degree of price stickiness, implementing a monetary policy that mitigates asset market segmentation is highly distortionary. This last result suggests that policymakers should resort to other instruments in order to correct financial imperfections.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 286.

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Date of creation: Dec 2004
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Handle: RePEc:chb:bcchwp:286

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