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Uncertain Potential Output: Implications for Monetary Policy in a Small Open Economy

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  • Guido Traficante

    (European University of Rome)

Abstract

This paper considers the uncertain potential output in a small open economy New Keynesian model. Uncertainty comes from the difficulty to distinguish shocks in domestic versus foreign components of potential output in real time. In such a setup, the expansionary effects coming from an increase in potential output are reduced in size because, after an increase in productivity (foreign output) agents and the central bank believe that there is also a negative shock to foreign output (productivity). The paper also shows that the Taylor rule that guarantees the largest welfare does not include a term in the exchange rate. Finally, the exchange rate peg may perform better than an independent monetary policy, especially in the case of incomplete information.

Suggested Citation

  • Guido Traficante, 2021. "Uncertain Potential Output: Implications for Monetary Policy in a Small Open Economy," Open Economies Review, Springer, vol. 32(5), pages 955-973, November.
    • Handle: RePEc:kap:openec:v:32:y:2021:i:5:d:10.1007_s11079-021-09650-6
    DOI: 10.1007/s11079-021-09650-6
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    More about this item

    Keywords

    Small open economy; Exchange rate regime; Monetary policy rules; Uncertainty; Potential output;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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