Journal
JOURNAL OF MONETARY ECONOMICS
Volume 49, Issue 5, Pages 989-1015Publisher
ELSEVIER
DOI: 10.1016/S0304-3932(02)00132-0
Keywords
open economy; interest rate rules; business cycles
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This paper computes welfare maximizing Taylor-style interest rate rules, in a business cycle model of a small open economy. The model assumes staggered price setting and shocks to domestic productivity, to the world interest rate, to world inflation, and to the uncovered interest rate parity condition. Optimized policy rules have a pronounced anti-inflation stance and entail significant nominal and real exchange rate volatility. The country responds to an increase in external volatility by holding more foreign assets. The policy rule affects the variance and the mean of consumption. The effect on the mean matters significantly for welfare. (C) 2002 Elsevier Science B.V. All rights reserved.
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