TY  - JOUR
AU  - Engel,Charles
TI  - Currency Misalignments and Optimal Monetary Policy: A Reexamination
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14829
PY  - 2009
Y2  - April 2009
UR  - http://www.nber.org/papers/w14829
L1  - http://www.nber.org/papers/w14829.pdf
N1  - Author contact info:
Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu
AB  - 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.
ER  -