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- Title
Exchange Rate Pass-through, Nominal Wage Rigidities, and Monetary Policy in a Small Open Economy.
- Authors
Hyuk-Jae Rhee; Jeongseok Song
- Abstract
This paper discusses the design of monetary policy in a New Keynesian small open economy framework by introducing nominal wage rigidities and incomplete exchange rate pass-through on import prices. Three main findings are summarized. First, with the existence of an incomplete exchange rate pass-through and nominal wage rigidities, the optimal policy is to seek to minimize the output gap, the variance of domestic price and wage inflation, as well as deviations from the law of one price. Second, the CPI inflation targeting Taylor rule is welfare enhancing when there is a technological shock to the economy. The exception occurs when there is a foreign income shock, which minimizes welfare losses under the domestic inflation targeting Taylor rule. Last, two stylized Taylor rules turn out to be a bad approximation, but the modified Taylor rules that respond to the unemployment gap rather than the output gap are a closer approximation to the optimal policy.
- Subjects
EXCHANGE rate pass-through; MONETARY policy; FREE trade; EFFECT of inflation on wages; FOREIGN exchange rates
- Publication
East Asian Economic Review (EAER), 2018, Vol 22, Issue 3, p337
- ISSN
2508-1640
- Publication type
Article
- DOI
10.11644/KIEP.EAER.2018.22.3.347