Monetary policy and Tobin taxes: a welfare analysis

This paper studies the choice of monetary policy regime in a small open economy under productivity shocks and noise traders in forex markets. We focus on two simple rules: fixed exchange rates and inflation targeting. We contrast the above two rules against optimal policy with commitment. In general, the presence of noise traders increases the desirability of a fixed exchange rate regime. We also evaluate the welfare impact of Tobin taxes on capital flows. These taxes help unambiguously in the absence of productivity shocks; their welfare impact under productivity shocks depends on the monetary regime in place and the trade elasticity between domestic and foreign goods.