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Optimal monetary policy in a small, open economy: a general-equilibrium analysis

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  • Charles T. Carlstrom
  • Timothy S. Fuerst

Abstract

This paper uses a model of a small, open economy to address two monetary policy issues: 1) What restrictions on the policy rule ensure that the central bank does not introduce real indeterminacy into the economy? and 2) What is the optimal long-run rate of inflation? The model's simplicity makes analyzing determinacy issues remarkably transparent. As for long-run inflation rates, a small, open economy takes the foreign nominal interest rate as a given. To the extent that this rate distorts domestic behavior, positive domestic nominal rates (in contrast to Friedman's celebrated optimum quantity of money) play a role.

Suggested Citation

  • Charles T. Carlstrom & Timothy S. Fuerst, 1999. "Optimal monetary policy in a small, open economy: a general-equilibrium analysis," Working Papers (Old Series) 9911, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:9911
    DOI: 10.26509/frbc-wp-199911
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    Cited by:

    1. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
    2. Alexandre Cunha, 2004. "The Friedman Rule in a Two Sector Small Open Economy," Econometric Society 2004 North American Summer Meetings 530, Econometric Society.
    3. Hakan, Yilmazkuday, 2009. "Is there a Role for International Trade Costs in Explaining the Central Bank Behavior?," MPRA Paper 15951, University Library of Munich, Germany.
    4. Alexandre Cunha, 2008. "The optimality of the Friedman rule when some distorting taxes are exogenous," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 35(2), pages 267-291, May.
    5. Bullard, James & Singh, Aarti, 2008. "Worldwide macroeconomic stability and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages 34-47, October.
    6. Ho Wai-Ming, 2020. "Liquidity constraints, international trade, and optimal monetary policy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(2), pages 1-29, June.
    7. De Fiore, Fiorella & Liu, Zheng, 2002. "Openness and equilibrium determinacy under interest rate rules," Working Paper Series 173, European Central Bank.
    8. Julián Pérez Amaya, 2006. "Evaluación De Reglas De Tasa De Interés En Un Modelo De Economía Pequeña Y Abierta," Borradores de Economia 2638, Banco de la Republica.
    9. Cengiz, Gulfer & Cicek, Deniz & Kuzubas, Tolga Umut & Olcay, Nadide Banu & Saglam, Ismail, 2007. "A Monetary Union Model with Cash-in-Advance Constraints," MPRA Paper 4248, University Library of Munich, Germany.
    10. William Barnett & Unal Eryilmaz, 2022. "Monetary Policy and Determinacy: An Inquiry in Open Economy New Keynesian Framework," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 202203, University of Kansas, Department of Economics.
    11. Charles T. Carlstrom & Timothy S. Fuerst, 2002. "Taylor Rules in a Model that Satisfies the Natural-Rate Hypothesis," American Economic Review, American Economic Association, vol. 92(2), pages 79-84, May.
    12. Yasuo Hirose, 2008. "Monetary Policy and Sunspot Fluctuation in the U.S. and the Euro Area," Bank of Japan Working Paper Series 08-E-7, Bank of Japan.
    13. De Fiore, Fiorella & Liu, Zheng, 2005. "Does trade openness matter for aggregate instability?," Journal of Economic Dynamics and Control, Elsevier, vol. 29(7), pages 1165-1192, July.
    14. Julian Pérez Amaya, 2006. "Evaluación de Reglas de Tasa de Interés en un Modelo de Economía Pequeña y Abierta," Borradores de Economia 385, Banco de la Republica de Colombia.

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    Keywords

    Monetary policy; Inflation (Finance);

    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
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General

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