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Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response?
How should monetary policy respond to capital inflows that appreciate the currency, widen the current account deficit and cause domestic overheating? Using the workhorse open-macro monetary model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, solve for the optimal targeting rules under cooperation and characterize the constrained-optimal allocation. The answer is sharp: the optimal monetary stance is contractionary if the exchange rate pass-through (ERPT) on import prices is incomplete, expansionary if ERPT is complete–implying ...
Employment, Wages and Optimal Monetary Policy
We study optimal monetary policy when the empirical evidence leaves the policymaker uncertain whether the true data-generating process is given by a model with sticky wages or a model with search and matching frictions in the labor market. Unless the policymaker is almost certain about the search and matching model being the correct data-generating process, the policymaker chooses to stabilize wage inflation at the expense of price inflation, a policy resembling the policy that is optimal in the sticky wage model, regardless of the true model. This finding reflects the greater sensitivity of ...