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Optimal Monetary Policy in an Open Economy

Peter J. Stemp, Stephen J. Turnovsky

NBER Working Paper No. 2018 (Also Reprint No. r0971)
Issued in September 1986
NBER Program(s):International Trade and Investment Program, International Finance and Macroeconomics Program

This paper analyzes the optimal intertemporal tradeoff between inflation and output in an open economy under perfect foresight. The announcement of the optimal plan may, or may not, generate an initial jump in the exchange rate. That depends upon the real adjustment costs, which such unanticipated changes impose on the economy. In the case that such jumps occur, the question of time consistency of the optimal policy arises. A time consistent solution is obtained provided: (i) the policy maker is not too myopic; (ii) the adjustment costs associated with the jump in the exchange rate are of an appropriate form. The optimal monetary rule is derived and properties of this rule, as well as the overall optimal adjustment of the economy are discussed.

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Document Object Identifier (DOI): 10.3386/w2018

Published: Stemp, Peter J. Stemp and Stephen J. Turnovsky. "Optimal Monetary Policy inan Open Economy," European Economic Review, Vol. 31, No. 5, July 1987, pp. 1113-1135.

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