Monetary policy rules and the exchange rate

A stochastic sticky-price general-equilibrium model is employed to explore the welfare effects of optimal monetary policy and of a range of simple targeting rules. Idiosyncratic shocks to the traded and the non-traded goods sectors may make it impossible for monetary policy to achieve an efficient sectoral resource allocation within countries and avoid inefficient relative price changes across countries. An inward-looking monetary policy is generally not optimal. Which simple, i.e. non-optimal, targeting rule best approximates the fully optimal rule depends on the elasticity of intratemporal substitution. Policies of producer price targeting, consumer price targeting and exchange rate targeting may be the best option for different values of the intratemporal substitution elasticity. Nominal income and monetary targeting generally perform worst.