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American Economic Review: Vol. 101 No. 6 (October 2011)

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Currency Misalignments and Optimal Monetary Policy: A Reexamination

Article Citation

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

DOI: 10.1257/aer.101.6.2796

Abstract

This paper examines optimal monetary policy in an open-economy two-country world with sticky prices under pricing to market. We show that currency misalignments are inefficient and lower world welfare. We find that optimal policy must target consumer price inflation, the output gap, and the currency misalignment. The paper derives the loss function of a cooperative monetary policymaker and the optimal targeting rules. The model is a modified version of Clarida, Galí, and Gertler (JME, 2002). The key change is that we allow pricing to market or local-currency pricing and consider the policy implications of currency misalignments. (JEL E52, F31, F41)

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Authors

Engel, Charles (U WI)

JEL Classifications

E52: Monetary Policy
F31: Foreign Exchange
F41: Open Economy Macroeconomics


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