NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Currency Misalignments and Optimal Monetary Policy: A Reexamination

Charles Engel

NBER Working Paper No. 14829
Issued in April 2009
NBER Program(s):   IFM   ME

This paper examines optimal monetary policy in an open-economy two-country model with sticky prices. We show that currency misalignments are inefficient and lower world welfare. We find that optimal policy must target not only inflation and the output gap, but also the currency misalignment. However the interest rate reaction function that supports this targeting rule may involve only the CPI inflation rate. This result illustrates how examination of "instrument rules" may hide important trade-offs facing policymakers that are incorporated in "targeting rules". The model is a modified version of Clarida, Gali, and Gertler's (JME, 2002). The key change is that we allow pricing to market or local-currency pricing and consider the policy implications of currency misalignments. Besides highlighting the importance of the currency misalignment, our model also gives a rationale for targeting CPI, rather than PPI, inflation.

download in pdf format
   (324 K)

email paper

This paper is available as PDF (324 K) or via email.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w14829

Published: Charles Engel, 2011. "Currency Misalignments and Optimal Monetary Policy: A Reexamination," American Economic Review, American Economic Association, vol. 101(6), pages 2796-2822, October.

Users who downloaded this paper also downloaded these:
Devereux and Engel w7665 Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility
Engel w17116 The Real Exchange Rate, Real Interest Rates, and the Risk Premium
Adolfson, Laseen, Linde, and Svensson w14510 Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model
Crucini, Shintani, and Tsuruga w14835 The Law of One Price Without the Border: The Role of Distance Versus Sticky Prices
Clarida, Gali, and Gertler w7147 The Science of Monetary Policy: A New Keynesian Perspective
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us