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Optimal Monetary Policy in a Currency Area

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  • Benigno, Pierpaolo

Abstract

This Paper investigates how monetary policy should be conducted in a two-region, general equilibrium model with monopolistic competition and price stickiness. This framework delivers a simple welfare criterion based on the utility of the consumers that has the usual trade-off between stabilizing inflation and output. If the two regions share the same degree of nominal rigidity, the terms of trade are completely insulated from monetary policy and the optimal outcome is obtained by targeting a weighted average of the regional inflation rates. These weights coincide with the economic sizes of the region. If the degrees of rigidity are different, the optimal plan implies a high degree of inertia in the inflation rate. But an inflation targeting policy in which higher weight is given to the inflation in the region with higher degrees of nominal rigidity is nearly optimal.

Suggested Citation

  • Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2755
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    More about this item

    Keywords

    Optimal monetary policy; Currency area; Sticky prices; Welfare criterion;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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