TY  - JOUR
AU  - Devereux,Michael B.
AU  - Engel,Charles
TI  - Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7665
PY  - 2000
Y2  - April 2000
UR  - http://www.nber.org/papers/w7665
L1  - http://www.nber.org/papers/w7665.pdf
N1  - Author contact info:
Michael B. Devereux
Department of Economics
University of British Columbia
997-1873 East Mall
Vancouver, BC V6T 1Z1
CANADA
Tel: 604/822-2542
Fax: 604/822-5915
E-Mail: mbdevereux@gmail.com

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 develops a welfare-based model of monetary policy in an open economy. We focus on the extent to which monetary policy should be employed in maintaining the exchange rate.  The traditional approach maintains that exchange rate flexibility is desirable in the presence of real country-specific shocks that require adjustment in relative prices. However, in the light of empirical evidence on nominal price response to exchange-rate changes   specifically, that there appears to be a large degree of local-currency pricing in industrialized countries   the expenditure-switching role played by nominal exchange rates may be exaggerated in the traditional literature. In the presence of local-currency, we find that optimal monetary policy in response to real shocks pricing is fully consistent with fixed exchange rates. On the other hand, when real country-specific shocks are not important, and when a country's monetary sector is stable, the case for freely floating rates (a monetary policy in which exchange rates are not a consideration) is strengthened in the presence of local-currency pricing.
ER  -